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Diebold, Incorporated (NYSE:DBD)

Q1 2013 Earnings Call

April 30, 2013 10:00 am ET

Executives

John D. Kristoff - Chief Comminications Officer and Vice President

Henry D. G. Wallace - Executive Chairman of The Board, Principal Executive Officer and Chairman of Special (OTCPK:FCPA) Committee

George S. Mayes - Chief Operating Officer and Executive Vice President

Bradley C. Richardson - Chief Financial Officer and Executive Vice President

Mychal D. Kempt - Vice President of North American Operations

Analysts

Gil B. Luria - Wedbush Securities Inc., Research Division

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Julio C. Quinteros - Goldman Sachs Group Inc., Research Division

Paul Coster - JP Morgan Chase & Co, Research Division

Jeffrey T. Kessler - Imperial Capital, LLC

Zahid Siddique - Gabelli & Company, Inc.

Operator

Good day, everyone, and welcome to Diebold Incorporated's First Quarter 2013 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, John Kristoff. Please go ahead.

John D. Kristoff

Thank you, Camille. Good morning, and thank you for joining us for Diebold's first quarter conference call.

Joining me today are Henry Wallace, Executive Chairman; George Mayes, Chief Operating Officer; and Brad Richardson, Chief Financial Officer. Also with us in the room today and available to answer questions is Mychal Kempt, our Head of North American 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 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 charges, non-routine and amortization expenses and non-routine income 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. Finally, a replay of this conference call will be available later today from our website. I should also note that we intend to file our 10-Q this afternoon.

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 with that, I'll turn it over to Henry to open things up.

Henry D. G. Wallace

Thank you, John, and good morning, everyone. The first quarter loss we reported this morning was extremely disappointing to all of us at Diebold, but it was not unexpected. In fact it was in line with our internal forecast. In late 2012, as we developed our forecast for 2013, we could see a significant shift taking place in our North American business. This put significant downward pressure on our profitability.

At the same time, our 2013 profit outlook for Latin America/Brazil and Asia Pacific was projected to be weak in the first half and very much back-end loaded. These trends, together with our increasing need to reduce our cost structure, pointed to a very weak first and second quarter.

Faced with this situation, we moved quickly in January to develop a plan to change the trajectory of the company. We implemented senior management changes and are presently interviewing candidates for the new CEO. This process is going well and we remain focused on finding the right person for the job. Timing is still open, but I'm encouraged by the quality of candidates that we are seeing.

We established the position of a Chief Operating Officer and appointed George Mayes to that position. Our international business is significantly larger and more complex than it was a decade ago and we need real focus on driving the execution of our strategies and plans with a focus on speed, discipline and accountability in our operations around the world.

We've reorganized our product development, service and supply chain operations as global functions. This will speed up our capabilities to develop products, leverage best practices and improve processes to significantly drive operational excellence and lower costs across our regional operations. We have already executed a series of short-term actions to reduce personnel, other costs and discretionary spending to counteract declining profitability, and we should start to see the benefits from these actions as the year goes on.

And finally, we've kicked up a series of transformational work streams to significantly streamline the company and provide the foundation for moving Diebold to a top-performing company.

As we're undertaking these actions, the fundamentals of the company remain strong. We have experienced senior management -- a significant senior management team leading our efforts; in both the financial self-service and security markets, we have global scale, unparalleled service capabilities and great product offerings; and we are deeply trusted by our customers. In addition, we have a strong balance sheet and ample liquidity for our needs.

Our growth initiatives in bank transformation, integrated services, electronic security and emerging markets are progressing well and will drive future growth. However, growth for growth's sake is not acceptable. We need to grow the company on a profitable basis. And to this end, the team is really focused on rapidly fixing our financial position so that we can generate improved margins, which will provide leverage to our growth, generate the cash to fund our transformational initiatives and our other growth strategies, whilst at the same time continuing to return cash to our shareholders through dividends and opportunistic share repurchases. As such, we expect 2013 to be a year of rebuilding, taking the necessary action and making the appropriate investments to improve our financial condition and profitability of the company, and to position the company for future profitable growth.

We still expect 2013 on a non-GAAP earnings basis to be flat to down moderately from 2012 and on relatively flat revenue. George Mayes is going to take you through the details of our transformation plans. And then Brad Richardson will go through the financial results and the cost savings associated with the multi-year realignment plan.

So I'll hand it over -- the call to George and later we'll do the Q&A. Thank you.

George S. Mayes

Thank you, Henry. As previously mentioned, we have moved quickly with an increased sense of urgency to take the actions necessary to extract greater value from our company. The 3 key areas we are quickly making changes to better position the company include: organizational realignment, structural cost reductions and investments in growth. As we rebuild our company, we recognize the emergent opportunity in the markets we serve such as brands transformation, integrated services and electronic security. And we continue to invest in these areas. In order to realize positive acceleration, we are taking critical steps to shape the long-term trajectory of the company.

As Henry mentioned, we have been moving quickly to develop a multi-year global realignment plan including near- and long-term actions in order to accelerate the improvement in our performance. Most importantly, we are taking an approach that has been proven and tested. We are focusing on improving our critical business processes. This is different than in the past. This process focus will ensure that we sustain our gains in the future as we change the trajectory of the company.

We have set a target to reduce our cost structure by $100 million to $150 million. The targeted savings should be completed by the end of 2014 and the total savings are expected to be fully realized by the end of 2015. While this target is considerable, there is leverage in our business model that we have yet to realize.

The near-term actions the company has taken include reducing our headcount by 700 full-time positions primarily in North America and corporate operations. The majority of these job reductions have already taken place. We continue to rationalize in our manufacturing facilities by selling our operations in Lynchburg, Virginia and Lexington, North Carolina. In order to make sure that we have supplied the right partner for this activity, the sale was completed with a long-time material supplier.

We took additional actions to reduce our discretionary spend. This included restricting nonessential travel, reducing the number of company vehicles, canceling noncritical consulting engagements and reducing spending on all non-core marketing activities and other initiatives.

As we discussed in February, we created a flat centralized management structure. This new structure is now fully deployed and is enabling us to take swift action and drive clear accountability across our global operations. In addition, we've identified 4 long-term transformation initiatives. Our first initiative is geared towards globalizing our service organization and processes. This new structure provides the framework for managing the increasing global and complex nature of our services business. This enables us to maximize efficiencies, drive improved performance and customer satisfaction while reducing our service costs.

Second, we have created a unified global organization for new hardware and software solution development and management. This allows us to eliminate duplication of effort and we can leverage solutions developed regionally across the globe. This new organization will enable us to increase our speed to market and drive down the costs of our products.

Third, we are transforming our general and administrative cost structure by increasing utilization of our existing shared service centers in lower-cost regions. We are instituting common processes and leveraging industry best practices across the company.

Our last initiative is focused on our commercial effectiveness. This includes reevaluating our pricing strategies and reducing fixed costs within our sales organization globally. This important initiative will improve our speed to market, make us more responsive to our customers, while optimizing the management of our product life cycles.

To manage these initiatives, we have created a transformation management office or TMO. The TMO was made up of a core team of zinger executives within the company. The TMO will provide the governing structure and mechanisms required to ensure the execution of our key initiatives.

The TMO process will define and deploy common metrics. Most importantly, the TMO will provide the structure for their financial discipline and validation for all cost-reduction initiatives to ensure that the savings are realized and that they hit the bottom line. The TMO meets every 2 weeks to review the plan for each area and ensure that we are on track and taking corrective action to achieve our desired results.

We have taken decisive action over the past 90 days. I want to emphasize strongly that this is just the beginning of our efforts. We still have more work ahead of us to reach our long-term cost reduction target and return the company to a more positive growth outlook. As Henry indicated, we're very confident in our team's ability to deliver our goals moving forward.

From a strategic perspective, we continue to see significant opportunities in the marketplace, which align very well with our growth initiatives. For example, we continue to see adoption of branch transformation solutions, including deposit automation. In fact, we recently deployed a custom in-lobby terminal for Bank of America. This new solution includes the capability to interact with an off-site teller through videoconferencing and provides cash recycling technology, a first in the United States market.

Our integrated services business continues to grow and we now have approximately 20,000 ATMs under contract in North America alone. From an electronic security perspective, we've recently introduced a new security management tool called SecureStat, which will revolutionize how customers manage their security network and operations. This new software platform will give us key competitive advantage in the market, allowing us to further penetrate and grow our presence in electronic security.

Globally, we continue to build our leadership position in emerging markets. Diebold holds the largest market share in Brazil through leading-edge technology and services capability. We are also a leading ATM supplier and the largest managed service provider in India.

Additionally, Turkey is one of the fastest-growing ATM markets in the world. And with our recent acquisition of Altus, a leading IT service provider, we gained a good deal of scale from a service perspective in the country.

Now let's review our regional businesses beginning with Slide 13. Starting with North America, total revenue for the quarter was down 17%, driven by tough comparisons due to the strong regional bank business and related ADA and PCI upgrade activity in the prior year period. Financial self-service revenue in the region declined 24% driven by lower product volume, and security was relatively flat.

Total orders were down in the mid-single digit range. This is the result of a significant decline in regional bank orders, which is nearly offset by a record order entry quarter from the national accounts. As such, we continue to experience a significant mix shift between national and regional accounts negatively impacting our profitability.

Although the quarter was challenging, we made great progress on several key business initiatives. For example, we are seeing growing interest in our in-lobby terminal as evidenced by the recent national news coverage of Bank of America adopting this solution as part of its branch transformation strategy. This represents a critical element in the company's branch transformation growth strategy and demonstrates the value of Diebold's solution. Today, we have the hardware and the software in place that enables our partners to differentiate themselves in the marketplace while enhancing their customers’ experience.

In security, our team was recently recognized with an industry award for work on a security project with St. Regis Bal Harbour Resort in Miami Beach, Florida. The award honors security integrators that exemplified professionalism in sales, marketing and installation endeavors. We earned this top industry award for solving a complex security challenge by integrating multiple systems to strengthen the security responses across facilities.

Also during the quarter, we secured a major security hardware and services deal with one of the top banks in the U.S., which is now our singlest largest -- which is now a single largest electronic security customer. This is the most recent example supporting our strategy to grow the electronic security business within the financial industry.

Now turning to Latin America. Total revenue decreased 10% during the quarter due to negative currency impact of 7% and lower volume in the ATM business. Security revenue was up significantly as we continue to focus on growing our share in Latin America. In Brazil, the first quarter included results of GAS, the online and mobile banking security company we acquired in the third quarter of 2012. GAS is growing faster than we had anticipated, and we note that there's opportunity to leverage this technology in other regions.

Total orders in Latin America and Brazil decreased more than 30%. This is primarily related to a large order from Caixa for 3,800 ATMs in the prior year period resulting in a tough comparison.

As we discussed last quarter, we were expecting 2 major ATM tenders to occur in the first half of the year. We recently won the public bid related to one of these tenders, Caixa, for 6,500 units and expect to complete certification and begin order fulfillment in the second quarter. We remain optimistic in regards to the other public tender from Banco do Brasil for 10,000 ATMs, which is expected to occur in May.

Now let's move to Asia Pacific. In the Asia Pacific region, total revenue for the quarter increased 17%. We experienced strong order growth for more than 30% driven mainly by timing of product orders in China. Demand remains strong in Asia Pacific, and we expect moderate top line growth for the year in the region.

And finally, in EMEA, total revenue for the quarter increased 2% or 5% on a constant currency basis. This increase was driven mainly by activity in emerging markets such as Turkey, where we are gaining traction from our recent acquisition of Altus. Orders decreased in the low double digits as we continue to focus on fewer key markets where the company has a stronger competitive position and can generate better margins.

On another note, we secured a major win during the quarter in a key regional account in Italy for our recently developed Flex terminals. This reinforces our reputation with strategic customers and demonstrates the value proposition of this new series of self-service terminals.

In conclusion, we see opportunity in all of our core markets. We have taken definitive action to improve our performance. We recognized that to capitalize on these growth opportunities and profitability, we must continue to focus on reducing our cost structure. As Henry mentioned, we expect 2013 to be a rebuilding year, taking the swift and necessary actions I mentioned earlier in my comments in order to improve the financial condition and long-term profitability of the company. And as an organization, we are fully committed to making the changes necessary to get the company on a more positive path and deliver value to our shareholders.

With that, I'll turn the call over to Brad to review the quarter and quantify the cost-savings initiatives.

Bradley C. Richardson

Thank you very much, George, and good morning, everyone. Let me walk you through our first quarter financial performance. Then I would like to spend some time providing further details behind the rationale, objective and savings associated with the realignment plan we announced this morning. Finally, I will discuss our outlook for 2013.

As you can see on Slide 17, we reported total revenue for the quarter of $634 million, down approximately 9% from the first quarter 2012. This includes approximately 2% negative currency impact primarily related to the Brazilian reais.

In North America, revenue was down about 17%. As we noted on our year-end earnings call in February, the North American region is down off a very tough comparison to the prior year period. During the prior year period, we set a milestone for the highest first quarter revenue in earnings in the company's history. This was a result of a strong demand in the high margin regional bank business, driven by accelerated ATM installations related to the March deadline for ADA and PCI requirements for ATMs.

Revenue in Latin America was down about 10% mostly attributable to the timing of major ATM tenders in Brazil. The decline in the Americas was partially offset by revenue growth in Asia Pacific of approximately 17%, as well as positive growth in EMEA where we are encouraged with the continued progress of our restructuring efforts. However, profit margins in these regions are significantly below what we generate in North America, which impacted our global profitability during the quarter. Both product and service revenue decreased 17% and 4%, respectively. From a mix perspective, service represented 60% of the total revenue during the quarter.

Looking at our financial self-service business on Slide 19. First quarter revenue was $496 million, a decrease of 12% or 10% on a constant currency basis. Again, this was due to the decrease in ADA and PCI compliance-related volumes in the prior period in North America.

The security business on Slide 19 grew approximately 2% due to the strong growth from electronic security of 7%, as well as the GAS acquisition in Brazil in the third quarter of 2012, which contributed about $3 million in the first quarter.

Overall revenue was partially offset by declines in our physical security business. We are encouraged by the strong growth in new business and electronic security we booked in the financial and commercial markets in North America, where orders grew nearly 40% in the first quarter. This activity underpins our forecast for a strong second half.

Turning now to Slide 20, the total gross margin for the first quarter decreased 6.6 percentage points from 2012. Overall, both service and product margins were negatively impacted by the substantial volume drop in our North American regional bank business.

Service gross margins for the quarter decreased 4.8 percentage points from 2012. This decrease is mostly attributable to the lower installation volume in the regional bank business in North America, which caused a service mix differences, as well as a decreased utilization of our fixed cost structure. However, given the cost savings associated with the realignment of our global service organization, coupled with greater expected installation volume in the second half of the year, we anticipate service margins for the full year 2013 to improve over the 25.7% 2012 level.

Product gross margin for the quarter decreased 9.3 percentage points, which was almost all attributable to North America. In addition to the volume drop in North America, we saw a mix shift towards national accounts, which led to further margin deterioration between periods. Latin America also showed deterioration mainly due to significantly lower product volume against the fixed cost structure of our manufacturing plant in Brazil.

Moving on to non-GAAP operating expense on Slide 21. In the first quarter, operating expense as a percent of revenue was up 1 point due to the decline in revenue. However, our actual operating expense declined $6 million.

As George noted earlier, we continue to drive down spending in our operating cost structure through our transformation initiatives. We expect full year operating expense as a percent of revenue in 2013 to be about 1 percentage point lower than 2012, reflecting absolute cost reductions of approximately $30 million.

Now to Slide 22, non-GAAP operating margin in the first quarter decreased to 0.6% from 8.2% in 2012. We were impacted by the negative mix shift in North America and the dilutive impact from Brazil. While this decrease is quite significant, the performance was in line with our prior internal expectations. As I mentioned during the previous call, we knew that we were facing a weak start to the year and that our 2013 outlook was heavily dependent upon second-half performance.

Turning to the EPS reconciliation table on Slide 23. Non-GAAP EPS moved from $0.74 per share in the first quarter of 2012 to a loss of $0.04 per share in the current quarter. Our non-GAAP tax rate moved considerably from 23% in 2012 to more than 350% in 2013. The non-GAAP rate -- tax rate was unusually high because of the mix of income, which is more heavily weighted to the U.S. where the tax rate is significantly higher than foreign jurisdictions. For the full year, we expect the tax rate to be in the mid-20% range.

It's also important to note that below the operating profit line, other income for the quarter decreased by $8 million from the prior year period, which was also negatively impacted -- which also negatively impacted EPS by approximately $0.10 per share. This was attributable to lower investment income primarily in Brazil, and foreign exchange losses related to the devaluation of the Venezuelan bolivar.

Turning to cash flow on Slide 24. Free cash used for the first quarter 2013 was $41 million compared with a free cash use of $38 million in the first quarter of 2012. In contrast, our first quarter 2011 was a free cash use of $101 million. Considering the impact of the regional bank business had on the first quarter 2012 net income, I am pleased with our position at this point in the year. We're well positioned to achieve our full year free cash flow guidance of more than $100 million.

Slide 25 highlights the progress we have been making on our cash conversion cycle. In the first quarter, we saw considerable improvement in our cash conversion cycle from 77 days to 72 days. This was primarily driven by an improvement in inventory turns.

Looking at Slides 26 and 27, days sales outstanding deteriorated by 12 days from the prior year, moving from 48 to 60 days. A higher mix of revenue from U.S. national accounts and Asia Pacific where customer payments tend to be slower than in other regions, adversely impacted DSO for the current quarter. Inventory turns improved by approximately 1 turn over 2012 at 5.2 turns.

Moving next to liquidity and net debt on Slide 28. We finished the quarter in a net debt position of approximately $82 million, an increase of $60 million from the net debt position at the end of 2012. In addition from a transparency standpoint, I'd like to update you on 2 areas regarding our liquidity and financial stability.

We had $75 million of our private placement notes mature in March. I will be meeting with insurance companies this week to raise approximately $150 million in private placement notes. The funds will be used to pay down our revolver and allow for expanded capacity for investment in the business.

The second area I wanted to provide an update is on our pension funding status. On a mark-to-market basis, on December 31, 2012, we were funded at 76% of the projected benefit obligation. And at the end of the first quarter 2013, we were funded at 81%. While we are not required to provide further additional funding to the plan, we are evaluating a voluntary contribution of $30 million by the third quarter through the use of Treasury shares.

Moving to Slide 21 -- 29, excuse me, I would like to provide a brief update on our compliance initiatives. We are actively engaged with the DOJ and SEC working towards a resolution of the FCPA matter. In addition, we are continuing to defend our positions on the previously disclosed Brazil tax matter and the ongoing shareholder class action lawsuit related to the prior SEC restatement. The resolution of any of these matters could be material to our financial results moving forward.

Now I'd like to walk you through the details around the multi-year realignment plan we announced today. Over the past several years, we have seen decent revenue growth. However, that has not translated into improved profitability as 2012 represented the fourth straight year of operating margins between 6% and 7%. In addition, our free cash flow in 2012 was substantially below our historical average.

There are several key situations that have negatively impacted our revenue and profit growth over the last several years. The cumulative effect of the following key areas has led to overall slow revenue growth and ultimately an erosion of the company's overall profitability leading into this year.

First in North America, we have a very strong market position and generally good profitability. But it is a mature market with low revenue growth and a highly cyclical regional bank business. Over the last several years, the company has become increasingly dependent on this market to drive overall financial performance.

Second, the Asia Pacific market offers a high revenue growth opportunity, but the proliferation of many local competitors, particularly in China and India, has resulted in sustained price erosion throughout the region creating significant margin pressure.

In Brazil, we've maintained our market share position despite the loss of business from Bradesco. However, Bradesco purchasing patterns were fairly steady and provided a level loading effect to the business. The vast majority of the remaining business in Brazil is driven by large auction tenders, which lead to increased volatility and competitive pricing pressures. In addition, the lottery and election system businesses there is very cyclical.

Finally, our administrative cost structure is very U.S.-centric and has been negatively impacted by significant increases in pension expense, which has grown from near 0 in 2008 to an expected $30 million in 2013. Also, we've made necessary investments in our legal, compliance and IT infrastructure.

The sum of these effects has increased business volatility and continued price erosion in certain markets combined with our high fixed cost structure that is not competitive with industry peers. The result has been unacceptable shareholder returns that are underperforming against our peers and the market as a whole.

In order to improve our financial performance and reverse this trend, we have developed a plan to take transformative actions to accelerate our operational execution and change the rate of improvement. From a strategic perspective, we are making necessary investments in growth in our core markets and emergency -- emerging adjacency, such as electronic security and branch transformation.

However, it's also critical that we address our cost structure to improve our competitive position and enable us to accelerate investment in our growth initiatives. As George stated, we aim to reduce our cost structure by $100 million to $150 million. We have reviewed and assessed our company-wide operating model, including benchmarking our costs with key peers. As a result, we believe we can generate meaningful cost improvements in the specific areas George outlined in his comments.

We expect to reinvest a portion of the savings resulting from our realignment plan in R&D to speed new solution to market. Also, we will invest in improved infrastructure, such as information technology systems to execute on our electronic security and financial self-service strategies. The remaining savings will be used to improve our profitability, as well as offset ongoing price erosion, wage inflation in emerging markets and volatile commodity prices in our core business. Given these factors, the company expects that approximately 50% of the savings will positively impact operating profit on a go-forward basis.

The substantial portion of the actions necessary to achieve the targeted savings should be completed by the end of 2014, and the total savings are expected to be fully realized by the end of 2015. We incurred restructuring charges of approximately $10 million in the quarter resulting from this realignment plan. We estimate additional future restructuring costs of between $15 million to $30 million related to the plan.

The actions the company has taken to date are expected to account for, approximately, $60 million of the overall savings, which is already included in our 2013 outlook. These actions, as George outlined, include reducing headcount, rationalizing manufacturing facilities, cutting discretionary spend and globalizing certain aspects of our management structure. The ultimate goal of all of these actions is to improve cash flow to generate the investment capacity required to execute on our growth strategies.

Now I'll address our 2013 outlook on Slide 34. We still expect 2013 non-GAAP earnings to be flat to down moderately from 2012 and for revenue to be relatively flat. However, we have increased confidence in our outlook based on where we are with the cost savings initiatives we announced today and our order growth in specific areas such as U.S. National Accounts, Asia Pacific and electronic security.

That said, Brazil remains a wildcard for 2013. While we have won one of the largest tenders, it came in later than expected and at lower margins. And we still have several other options that yet -- have yet to take place and the outcome around timing and profitability is uncertain. This has negatively impacted our second quarter forecast and risk remains for the full year.

Moving on to free cash flow guidance on Slide 35. As I mentioned earlier, we are reiterating our prior guidance provided in February 2013. Our expectations are based on the following assumptions: flat to moderately down earnings; relatively stable core working capital elements and prepayment 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 settlement, 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, I want to reiterate a few comments. Despite facing a challenging first quarter, we are confident that executing our realignment plan will allow us to deliver on our growth strategies. In addition, our balance sheet positions us to fully capitalize on our growth opportunities and deliver sustained shareholder value. And our leadership team is fully invested in and committed to the company's success.

With that, I'll turn it back to John.

John D. Kristoff

Thanks, Brad. Camille, we'll take our first question now, please.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Gil Luria with Wedbush.

Gil B. Luria - Wedbush Securities Inc., Research Division

In terms of Brazil as a big swing factor, last quarter you quantified the swing factor as about $30 million of operating income. A quarter into the year with knowing that we won one of those deals, is that swing factor any lower at this point in time?

Bradley C. Richardson

Yes, Gil. It's Brad. I think that's still a good approximation.

Gil B. Luria - Wedbush Securities Inc., Research Division

And then in terms of those deals, the one you won, as well as the 2 that are still out there, should you win them, the mix of rollouts, would it be mostly this year, mostly next year? What's the ratio between the ATMs you would rollout this year versus next year?

Bradley C. Richardson

Yes, Gil, I mean, I think it's roughly about half would come into -- maybe half to a little less than a half would come into the 2013 and the following would be into 2014.

Gil B. Luria - Wedbush Securities Inc., Research Division

Got it. And finally, within your EMEA region, do you see any noticeable changes in terms of the environment? Obviously you're in a limited, a more limited set of countries right now, but has spending slowed down or picked up in terms of the overall banks within those countries?

Bradley C. Richardson

No, Gil, I would say it's stable at this point.

Operator

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

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

A couple of questions. From an SG&A standpoint, how much of your spend, would you say, is fixed versus variable kind of before executing on this realignment and restructuring? And what will that ratio look like in your mind post these efforts?

Bradley C. Richardson

Yes, I mean, I think, Matt, I mean the vast majority of that -- the SG&A is fixed. Let's just say, 90% of it's fixed. And with the cost reductions that we're making, some of them are in the sales area, but the disproportion in our amount in the G&A area, I would expect that ratio maybe to be 80, 80-20.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then as you think about realization of these savings, what sort of revenue growth is implied, if any, on capturing, say, the $50 million to $75 million down to operating profit?

Bradley C. Richardson

I think, as you look at the overall assumption here, it's based upon very, very minimal revenue growth for the company. Such that, as revenue growth comes and we're able to leverage the company and generate higher operating profit.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Maybe just to help frame up this small bank dynamic, I believe you disclosed what your small bank revenue was in the first quarter of '12. Can you review that again and then maybe give us an idea as far as where that stood in the first quarter of '13? And I guess embedded in this sort of flat to moderately down EPS outlook, what is your view of small bank for the full year?

Bradley C. Richardson

Let me answer the first part of this and then I'll let Michael kind of give you what's going on in the marketplace. And without giving you the specific revenues for the regional community bank, what I would say, and I think it kind of speaks to the results that we're announcing here this morning, is that in the first quarter of last year within our financial self-service business here in North America, we were about 80% of the revenues were regional community banks. And in the first quarter of this year, it's about 40% regional and community, 60% national. So you can see how that has had a very significant impact. You can see it at the product margin level, but you can also see it at the service margin. Regarding the outlook, Mychal, do you want to comment?

Mychal D. Kempt

Matt, it's Mychal. We've seen in this regional bank business kind of return to what I would say more of a historical normalized rate. And although that's not where we want to be, certainly, we're encouraged by improved visibility and pipeline growth that I've seen come out in the first quarter. I think that improved visibility and pipeline growth really kind of supports our full-year view. Pipeline is being driven predominantly by Windows 7 and EMV-type upgrades, certainly activity around branch transformation and deposit automation.

Operator

And we'll take our next question from Julio Quinteros with Goldman Sachs.

Julio C. Quinteros - Goldman Sachs Group Inc., Research Division

Just real quickly, can we go back through the capital allocation plans for the remainder of the year. It sounded like you guys were planning on doing a private placement and then just thinking through the remainder of the year in terms of free cash flow expectations beyond the debt raising. Also it kind of sounds like you're also committing to the continued dividend payout, correct?

Bradley C. Richardson

Right. So our free cash flow estimate, again, we're estimating to be somewhere around $100 million in free cash flow. And again, that supports the -- that $100 million is after reinvestment of $60 million of capital investments. Regarding kind of the what we're doing on the debt side is with the private placement notes maturing, again, $75 million matured in March, we're out raising some money to refinance, if you will, that $75 million, as well as to give us an incremental $75 million that we will use to pay down the revolver at this point. Both of those actions give us then the capacity that we need obviously to move forward.

Julio C. Quinteros - Goldman Sachs Group Inc., Research Division

Okay, and what's the put and take against the pension expense itself? It sounded like there was a $30 million expense there as well?

Bradley C. Richardson

Yes, so that's -- there's 2 $30 millions that we talked about in the prepared remarks. $30 million is the expense right now that we're projecting for 2013. Again, that's up from in 2008, where it was essentially 0. So that was the reference to the $30 million, is the expense that's hitting the company, really about 1% on the operating margin line. What I mentioned is that regarding funding is, at the end of last year, we were about 76% funded. With the performance of the market right now, we're about 81% funded. We don't have any mandatory requirements to fund the plan this year, but we are looking potentially to put in about $30 million of Diebold's stock into the plan. We'll make that decision at this point in the third quarter this year.

Operator

And we'll take our next question from Paul Coster with JPMorgan.

Paul Coster - JP Morgan Chase & Co, Research Division

So the restructuring obviously yields some opportunity to reinvest. And it sounds like there's 3 growth areas of branch transformation, electronic security and integrated services, is that correct? And then can you just sort of give us some sense of what you think the growth prospects for each of those are?

George S. Mayes

Yes, I would just start with branch transformation. I think, as we begin to have these conversations with -- in some of the key financial institutions, they have several kind of reasons that they're -- rationales as they're looking at branch transformation. Obviously, they're looking at it to facilitate their cost reduction. But I think more importantly, they're having the conversations because it gives -- it enables them a way to differentiate themselves with their customer base. I think it's very early in the conversation to give you a specific number around the growth rate, but I will tell you that we are having several conversations with large institutions and there appears to be a significant appetite to invest in our hardware as we go forward and for us at Diebold that bodes well for us because we have a proven solution in place that's being tested and being certified, and so we think we have a significant opportunity there. In terms of electronic security, we believe that our growth is going to be in that 3% to 4% range. And I think there might be some opportunity to do better than that. But clearly, I think for now that, that's probably the expected range that we're going to be in. In terms of integrated security, that the growth rate would be a little bit higher than where we are with the electronic security piece. I think those 3 strategies clearly underpin our long-term aspirations to grow in the 4% to 6% range as a total company and then when you look at the various markets, each of them have different growth rates. But in summary, we believe that our strategies will enable us to achieve that 4% to 6% growth rate that we've articulated in previous meetings.

Paul Coster - JP Morgan Chase & Co, Research Division

You've made some pretty significant internal changes here. Do you feel that you've compromised any of your growth initiatives? Have there been any sort of revenue impacts from these cutbacks?

George S. Mayes

No. I would tell you, I think the most encouraging thing, as I said in my comments, in the past as we've taken these initiatives, we probably have not been as focused around making sure that we keep and maintain the capabilities within the company. And so, we have taken a very, very focused look at maintaining our core capabilities and in new product development from a hardware and software standpoint. We have taken a particular effort in making sure that we maintain the ability to satisfy our customers' requirements. We want to make all of these changes transparent to our customers. So if anything as we've gone through this diligence, I believe that we've enhanced our ability to satisfy our customers. And through the efforts of streamlining our new product development organization and rationalizing our processes throughout the organization, that we have increased our ability to deliver speed to market as we go forward. So I would tell you that if anything I think that we've enhanced the capabilities of the organization through these efforts. And as I said, I just want to emphasize that we're at the beginning of this process. And as we go forward, it will accelerate the pace and be able to deliver in a much more meaningful, crisper way to our customers the new products and increase our speed to market while reducing our cost.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. Last question, many of us sort of feel that the company needs to -- I don't know if many of us. I believe that the company needs to move up the food chain a little bit by tilting revenues towards software somewhat. Do you concur? And to what extent should we view the selection of the CEO as a litmus test for your sort of commitment to that strategy?

Henry D. G. Wallace

Well, let me answer that. This is Henry. Let me answer that on behalf of the team. The answer is, yes, we do see that there's real benefit in moving up the food chain, and software is clearly one of those areas and we've talked about that several times. And it goes through all the corporate strategies. And so as we think about the next leader of the company, that's one of the areas that we think is very important and that's certainly a big factor in our minds as we think about that.

Operator

And we'll take our next question from Jeffrey Kessler with Imperial Capital.

Jeffrey T. Kessler - Imperial Capital, LLC

Could you give an indication of what seasonally free cash flow sets out to be by quarter, realizing that obviously you have capital commitments that pop up that are unusual during the course of the year, such as, perhaps installations in Brazil, things like that. But normally, what would we be expecting in terms of the seasonality of your free cash flow?

Bradley C. Richardson

Jeff, generally the first quarter is our weakest. And again, you saw that in terms of the negative $41 million that we announced here this morning, again, in line with the prior year free cash flow use. What you see then typically is the second and third quarters are moderately kind of neutral, if you will, and then the fourth quarter is when the vast majority of our free cash flow is generated. And that's just really a function of the way certain contracts work on the service side of the business here in North America, as well as certain kind of government bank activity outside of North America.

Jeffrey T. Kessler - Imperial Capital, LLC

Okay. And with regard to getting up to your in-line with industry peers, particularly with your fixed cost levels. Without going into any specifics on who your -- the industry peers are, what are the improvements you need to make? And what are the types of things that your industry peers are doing with fixed cost that you need to get up to?

George S. Mayes

Yes, without comparing ourselves to our industry peers, our focus is really looking at our fixed cost from a Diebold perspective. And we believe that there's several additional things that we can do around looking at, obviously, our organizational structures, looking at our channel and participation strategies in each of our regions, going into each business region and doing a detailed analysis by line of the individual fixed cost structure. There's several things that we are going to be focused on here in the future and we think there's an opportunity, as I've said, the activities that we've taken thus far are just really the beginning. We believe that there's a significant opportunity to reduce our fixed cost and our operating expense as we go forward. And we will spend the next several weeks and months working towards that end.

Jeffrey T. Kessler - Imperial Capital, LLC

Good. Finally, last question. You mentioned that you were starting to begin to integrate or at least you had -- begin to have the product capability, service capability to start integrating initial electronic security products with financial services. Could you elaborate on that a little more?

George S. Mayes

Yes, I spoke about our SecureStat launch that we just launched down at the West Coast of the ISC, the Integrated Securities' Conference. And what that is, it's a tool that enables the integration of different security applications into one agnostic kind of web-based tool. And so it enables our partners or customers to take DVRs and fire alarms and sensing panels, access technology and to be able to look at it through one web portal. And so in our business, this is really a first in the industry. And because it's device agnostic, we believe that it really provides us an opportunity to leapfrog our competitors and really provides a compelling tool that any commercial or financial institution can use to kind of control their security environment. So we're very excited about it. We got extremely favorable reviews at the ISC. And we continue to have very critical conversations with customers who would like to use that solution going forward.

Operator

And we'll take our next question from Zahid Siddique with Gabelli & Company.

Zahid Siddique - Gabelli & Company, Inc.

I wanted to go back to your guidance. So you are projecting earnings to be modestly lower than 2012? And I think June 2012, you did about $2.07, let's call it $2.05. So if we assume $1.90 or $1.80 would be modestly lower that implies -- and if we do the math, Q3 and Q4, it implies that Q3 and Q4 earnings would more than double on a year-over-year basis. Is that a realistic assumption?

Bradley C. Richardson

Well certainly, again, I think the flat down moderately, I mean, I think you kind of dimensioned that. But if you really look at the second half of last year, you may recall that in particular in the fourth quarter, we ran into a series of operational issues in the company. And so certainly, as we sit here and we kind of think about the second half of this year, we're not anticipating kind of a repeat of those. So again, that provides a favorable year-over-year comparison. Then you look at, clearly, the cost take-outs that we've announced here this morning. Those are going on as we speak. Those have a second half benefit. In our prepared remarks, we talked about what's going on with the national accounts. Mychal spoke to, again, the momentum of -- albeit it's off of a low base, but the momentum that we have in the regional space, coupled with the normal backend loading of the Latin America business, including Brazil, which we've spoken to. Those all give us the basis for a stronger second half.

Zahid Siddique - Gabelli & Company, Inc.

To the degree that, earnings could actually double roughly or more than double in the second half?

Bradley C. Richardson

Yes, certainly. Again those factors that I just listed, serve as the basis for the full year guidance.

Zahid Siddique - Gabelli & Company, Inc.

Okay. And just last question, I think, if I heard you correctly, you said that the services margins would be better than 2012. Is that what I heard? And what were the margins again in 2012?

Bradley C. Richardson

For 2012, our service margin was 25.7%. And again, you will recall that last year, those margins fell off in the second half of the year due to some operational issues, as well as due to the investments that we were making to stand up Toronto-Dominion. And therefore again, we're expecting, with the cost actions coupled with the absence of some of the issues we had in 2012, to create a favorable year-over-year variance.

Operator

And we'll take a follow-up question from Matt Summerville with KeyBanc.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

A couple of questions. First, your pension expense is $30 million a year. If you were to prefund this $30 million with your stock, what would the EPS accretion be, Brad?

Bradley C. Richardson

Yes, that would be roughly, probably $0.03 or $0.04 in very rough terms. But we're not anticipating that, that funding's going to take place until the third quarter of this year, so you'd only get a partial year effect this year.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then, I want to make sure I understand. So your electronic security orders sounded like they were up 40%, but it sounds like you're looking for 3% revenue growth. Did I misunderstand something?

John D. Kristoff

Matt, that's for total security. And physical security is still down year-over-year. And then we've exited some segments as well, related -- you saw, we sold off our government security business and some other segments. We're not talking about orders, we're just talking about electronic security.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Got it. And then Brad, I think this is my last question. On your one -- your fourth quarter conference call, I believe you said the earning seasonality this year would be 20%, 25% first half, the remainder back half. Is that still true, in terms of how you're kind of modeling things out?

Bradley C. Richardson

Yes, I mean, I think given the order activity in Brazil and where the margins came in on the Brazil order, I think the backend loading has increased from that expectation that we gave at the fourth quarter call. But again, what we've done since that fourth quarter call is given some of the issues with Brazil as we have intervened on the cost actions in order to support the full year guidance that we're reaffirming here this morning.

Operator

And that does conclude today's question-and-answer session. Mr. Kristoff, at this time I will turn the conference back to you for any additional or closing remarks.

John D. Kristoff

Thanks, Camille. And thank you, everyone, for joining us this morning. As always, if you have follow-up questions, please feel free to contact me directly or Jamie Finefrock. Thank you.

Operator

And this does conclude today's presentation. Thank you for your participation.

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