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Executives

John D. Kristoff - Chief Comminications Officer and Vice President

Andreas Walter Mattes - Chief Executive Officer, President and Director

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

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

Analysts

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

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

Paul Coster - JP Morgan Chase & Co, Research Division

Jeffrey T. Kessler - Imperial Capital, LLC

Glenn Mattson - Sidoti & Company, LLC

James Justin Hughes - Philadelphia Financial Management of San Francisco, LLC

Diebold, Incorporated (DBD) Q2 2013 Earnings Call August 6, 2013 10:00 AM ET

Operator

Welcome to the Diebold Second Quarter 2013 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to Vice President and Chief Communications Officer, John Kristoff.

John D. Kristoff

Thank you. Good morning, and thank you for joining us for Diebold's second quarter conference call. Joining me today are Andy Mattes, President and CEO; Brad Richardson, Executive Vice President and CFO; and George Mayes, Executive Vice President and COO.

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. Andy, Brad and George 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, nonroutine and amortization expenses, nonroutine income, deferred tax expense on foreign cash repatriation and a tax valuation allowance 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 be focused 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, excludes discontinued operations. Also, as part of our previously disclosed material weakness remediation related to indirect tax incentives, we continue to assess our indirect tax compliance in Brazil and are reviewing the accounting treatment of certain transactions. It is possible that financial results for certain periods may need to be further revised or restated as a result of this work, which may potentially delay the filing of our quarterly report on Form 10-Q for the period ended June 30, 2013. Therefore, financial results discussed today should be treated as preliminary and subject to change.

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 actual 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 the call over to Andy.

Andreas Walter Mattes

Thanks, John, and thank you to all of you for joining the call today. Clearly, the results we announced today are not in line with our capabilities and potential as a company.

In a moment, we will review our performance during the past quarter, level set our financial outlook and the rationale behind our guidance and discuss the actions we're taking to address our issues.

First, I think it's important for me to share my thoughts on Diebold after my first several weeks here to lend some perspective on our challenges and opportunities.

Let me start with initial assessment of the company. There are multiple unique operating models at Diebold, and I don't know any other way to learn the business than to get underneath every piece of the operation. Along those lines, I've already visited 3 of our 5 geographic divisions, which account approximately for 70% of our employees and 75% of our revenues. I'm planning to visit our operations in Asia Pac and EMEA over the next few weeks.

Also, I had the pleasure of meeting with approximately 30 of our top customers during the past 2 months, I came away from those meetings knowing that we have a strong base of customers who are looking for us to help them solve a lot of their business challenges. There's a great deal of value here. We have many strong assets, especially in our service portfolio, and have a very recognized brand in the market. While we have a lot of work ahead of us, my overall assessment is that we have a great turnaround opportunity here.

Our immediate focus will be on the following fronts. As a company, we will get crisper regarding our decisions, actions and execution. To help facilitate our execution, we're in the process of closing out some of our pending legal compliance issues, which have created a burden on our management's team focus. Brad will discuss our efforts there in more detail later in the call.

The company has started to pay closer attention to reducing its cost structure and to become more variable in nature and better aligned with industry peers. We will continue down this path and accelerate our cost reductions. We will sharpen our focus on cash generation. We have experienced a negative free cash flow trend over the last 3 years. Brad and George will discuss in more details our plans to improve cash management within the operations.

We will recruit top-tier talent and empower our employees to drive change. To lead our transformation and drive our turnaround agenda, we recently recruited Stefan Merz from HP, where he served as Vice President of Sales Strategy and Operations for the Enterprise group. We will upgrade our service operations from a service delivery to a service business approach, leveraging core capabilities to better capture the value and grow the services that we are providing.

We will implement a major overhaul to our IT infrastructure to lay the foundation for solid growth and performance. This requires heavy lifting. The journey will last at least 2 to 3 years and will put additional pressure on our near-term P&L. However, it will enable us to drive continuous productivity enhancement and position us for long-term growth.

Turning to growth, a key area of focus. During my initial days here, I've seen a lot of exciting opportunities that give me confidence in Diebold's growth potential going forward. In particular, electronic security continues to be a part of our growth story moving forward as we continue to secure large wins in both the financial and commercial spaces based on high margin and recurring services. Also, our recent acquisition in Brazil, GAS, is a very encouraging component of our future growth strategy. Four of the 5 major Brazilian banks already use our anti-fraud security solution, which protects nearly 70% of all Internet banking transactions in Brazil. The next step for us is to better leverage these pockets of innovation in other markets around the world. This holds especially true in the managed services space where we will go to an invent once, reuse often philosophy.

Moving onto guidance. You'll note that we have significantly reduced our outlook for 2013. Our prior forecast was too back-end loaded and dependent on major tenders at Brazil, as well as an uptick in demand in the U.S. regional bank space. We have taken these 2 prior assumptions out of our current guidance.

While our order book is encouraging, many of these orders will not revenue until very late this year and might fall into 2014. Brad will be walking you through more details regarding the rationale behind our outlook later in the call.

In the last earnings call, management highlighted $100 million to $150 million cost savings plan to be completed by the end of 2015. I would like to reinforce my commitment to this plan. Since that time, we have already identified $150 million in targeted savings, and we're accelerating the timing and underpinning of our transformation initiative moving forward. George will give you more details on this front later.

As part of our cost savings actions, we will freeze the company's U.S. pension plan and offer early retirement to over 1,200 U.S. employees over the next several weeks. Brad will address how these actions will impact our P&L, balance sheet and capital allocation strategy during his comments.

Moving forward, I believe in setting clear objectives, implementing tactical plans and holding people accountable against stated goals as a fundamental belief in balancing cost discipline against focused investment in growth. George, Brad and the rest of the leadership team are in complete alignment in this regard. In his new role as COO, George has done a great job in laying the groundwork for operational excellence. Together, along with Brad and the rest of the leadership team, we're committed to instilling an execution-oriented culture within Diebold.

In conclusion, I believe our brand is strong and we have a deep customer relationship on which to build. However, to get more competitive in the marketplace and back on a winning trajectory, we'll focus on achieving an appropriate cost structure and investing in the systems and processes necessary to support the sustainable growth. This is where the majority of our time and effort will be focused in the near term. Getting costs out of the company will also improve our cash position and enable us to invest in the future of the company. It is important for us to act decisively and address the major issues that have been distracting us and get on the business of growing Diebold. This will help us to reestablish a winning spirit within the company.

Much of our success lies in our own hands. We have a lot of work in front of us, but I feel deeply confident about our future.

With that, I'll turn the call over to Brad.

Bradley C. Richardson

Thank you very much, Andy, and good morning, everyone. First, I would like to update you on our Brazil tax assessment situation. Second, I will walk you through our second quarter financials on Slide 14 through 24 in the supporting presentation. Third, I will discuss our balance sheet strategy and the impact of the additional cost savings initiatives on our P&L and balance sheet. Finally, I will provide additional rationale behind our revenue guidance for 2013 and an update on our free cash flow outlook.

As previously disclosed, one of our Brazilian subsidiaries was notified of a tax assessment of $133 million regarding certain Brazil federal indirect taxes for 2008 and 2009. We continue to evaluate the impact of this potential tax uncertainty and continue to believe that we have a strong legal and technical position in that matter.

As a result of the assessment in our previously disclosed related material weakness, we undertook a review of our overall compliance with Brazil indirect tax regulation. As part of that review, during the second quarter of 2013, we identified adjustments related to the 2008 to 2012 prior-year periods for federal indirect tax incentives in the amount of approximately $23 million, impacting product cost of sales. These adjustments are not related to the original tax assessment, and our prior period financial statement will be revised, prospectively.

As a result of revising our second quarter 2012 financials for this adjustment, there was an increase in previously reported costs of goods sold of $1.6 million, and a decrease of previously reported net income and diluted earnings per share of $1.2 million and $0.02 per share, respectively.

While we are comfortable with our self assessment of the federal indirect tax incentives, we continue to assess our exposure for state indirect tax compliance. We have a team on the ground in Brazil working this issue. As a result of this review, it is possible that financial results for certain periods may need to be a further revised or restated. Therefore, financial results we are sharing today should be treated as preliminary and subject to change. This review of the state indirect tax matter may also potentially delay our 10-Q filing.

Turning to our financial slide on Slide 14. Total revenue decreased approximately 5%. Financial self-service revenue decreased approximately 6%, while total security revenue increased approximately 4%, as our organic growth strategy for electronic security continues to take hold.

On Slide 17, the total gross margin was 22.9%, a decrease of 1.8 percentage points. Product gross margin declined 2.6 percentage points to 20.9%. Product margins were down in the second quarter as a result of lower overall volume and continued strength in the National Bank segment in North America, which carries lower product margins.

Service -- the service gross margin was 24.3%, a decrease of 1.6 percentage points from the second quarter of 2012, but increased sequentially by 1.2 percentage points from the first quarter of 2013. Our service gross margin decline is mainly attributable to 2 specific contracts in Brazil. We have taken the appropriate commercial steps to address this issue.

Operating expense on Slide 18 was relatively flat as a percentage of revenue, but decreased on a dollar basis by approximately $6 million as we realize benefits from our cost savings initiatives and lower selling expense.

On Slide 19, the operating margin declined by 1.9 percentage points to 4.3% in the quarter.

Let me spend a little time on Slide 20. You can see our EPS on a GAAP basis was $1.55 loss during the quarter, including restructuring charges of $0.08 per share. Nonroutine and amortization expenses of $0.55 per share included several items. First, while we do not have a final settlement at this point related to our FCPA matter, we made significant progress during the quarter and have reached an agreement in principal with the Department of Justice and the Securities and Exchange Commission. Under the terms of the proposed settlement, among other things, we would make a $48 million payment to United States government for disgorgement, penalties and prejudgment interest.

Further, we would have an independent compliance monitor for a minimum period of 18 months. Therefore, given the proposed settlement terms, we have increased our accrual by $28 million. We do not expect at this point the final settlement to vary materially from our current total accrual of $48 million.

Second, also included in the nonroutine and amortization expenses, we have reached a tentative agreement to settle the derivative class action lawsuit related to our 2008 financial restatement for $30 million, of which $12.5 million is covered under existing insurance policies. The lawsuit has been ongoing since the second quarter of 2010, and we are pleased to bring this legacy issue to a close.

Third, we have begun the process to repatriate approximately $258 million of cash from multiple international jurisdictions to the United States in order to pay down our domestic debt and enhance our liquidity in the United States. Further, we have begun to shift debt to the international jurisdictions to better align our debt with our cash generation activities.

The associated tax impact is approximately $43 million or $0.67 in the quarter. This reflects incremental taxes being provided for earnings that were previously taxed at a country statutory rate lower than the U.S. rate. Actual cash taxes associated with the repatriation is approximately $20 million. A combination of these factors brings us to a loss of $0.25 per share on a non-GAAP basis. Included in this loss is $0.51 per share related to a valuation allowance reserve established against net operating loss carryforward assets, reflecting the unfavorable financial performance of our Brazil manufacturing operations. Excluding this, non-GAAP earnings was $0.26 per share.

Moving onto free cash flow on Slide 21, the free cash used during the quarter increased $24 million year-over-year. Our days sales outstanding increased 11 days as a result of a mix shift in the United States from regional to national accounts. To accelerate and improve our cash generation activity, we have significantly increased our efforts internally to bring more cash discipline to the operations.

On Slide 22, net debt for the period was $156 million, a $55 million increase from the prior-year period. There were a number of developments during the quarter to strengthen the overall liquidity and financial capacity of the company. First, as previously mentioned, we plan to repatriate approximately $250 million of cash back to the United States. This repatriation reflects capping international cash and placing approximately $100 million of debt in foreign jurisdictions.

Second, as Andy mentioned, we are freezing our defined benefit pension plan for U.S.-based employees. The freeze, coupled with higher discount rates, is expected to save approximately $30 million per year and will reduce the underfunded status from approximately $150 million at end of 2012 to about $50 million at the end of this year. As a result of the reduced underfunded status, we have no plans to make voluntary contributions to the pension plan for the foreseeable future. Finally, the company is offering a voluntary early retirement program for U.S. employees. Until we know how many people take advantage of the program, we cannot provide a specific savings figure. However, based on an industry average take rate of between 25% and 45%, we anticipate a second half 2013 charge of between $40 million and $70 million, covering pension and severance-related expenses. This will result in approximately $15 million to $25 million in ongoing savings on a go forward basis.

The combination of the pension actions and the early-retirement program provides a strong underpinning for the $150 million in cost savings.

Now turning to Slide 24. In regards to our guidance for 2013, we expect full year revenue to be down 5% to 7% and earnings per share to be in the range of $0.79 to $0.89 per share on a non-GAAP basis, including a $0.51 tax valuation allowance charge. Excluding the tax valuation allowance, this leads to a non-GAAP earnings of between $1.30 and $1.40. We expect earnings to progressively improve as we move through the rest of 2013. However, this earnings growth is less than previously expected as we have adjusted our outlook related to 2 prior assumptions outlined in previous calls. First, in regards to the Brazil auctions, while we have won a couple of the large tenders as anticipated, the timing was later than expected and other opportunities have pushed out. Therefore, we are taking the revenue and earnings associated with these tenders out of our guidance for 2013. Second, the U.S. regional bank business is not expected to grow at the level previously anticipated. Orders remain stable. However, there is not been an uptick in demand as regional banks continue to remain cautious on their technology spend initiatives.

In regard to our free cash flow outlook for 2013, previously, we outlined free cash flow guidance of $100 million plus. As a result of our reduced earnings outlook, coupled with the expected class action lawsuit and FCPA settlement, and the cash taxes associated with our cash repatriation, we expect free cash use of approximately $25 million for the full year. This is subject to the variability and the timing of large settlement payments.

We are also making internal efforts to help improve our cash generation to mitigate the impact of the approximate $100 million in onetime items that I have discussed.

In closing, we have a lot of work in front of us. We are working aggressively to resolve our Brazil tax matter and remediate the underlying material weakness. The efforts are ongoing and the work is extremely complex. We have moved aggressively to bring our other compliance and legal issue towards closure so we can better focus our time and attention in our turnaround efforts. We are also working to restructure the balance sheet, improve free cash flow and address our underlying cost structure, all of which are critical to position the company for growth.

With that, I'll turn the call over to George.

George S. Mayes

Thanks, Brad. First, I'll briefly recap our performance during the quarter on a region-by-region basis. Then I'll provide an update on our cost reduction and multiyear realignment initiatives we introduced in April.

Beginning with the highlights in North America, total revenue for the quarter was down approximately 8%, driven mostly by lower product volume associated with ADA and PCI upgrade activity in the prior-year period.

The U.S. regional banks continue to remain cautious under technology spend initiatives. Total orders were down in the low-double digits, driven by the financial self-service business.

In contrast, we continue to see spending in the U.S. national account space in regards to technology such as deposit automation and electronic security systems and solutions. We also made progress on several key a business initiatives this quarter, including our most recent partnership with Paydiant, a mobile wallet provider, to enable the cardless Mobile Cash Access solution. We are currently in the process of evaluating global applicability and identifying the right network providers and mobile wallet partners in other regions. The Mobile Cash Access solution, as well as other recently launched emerging technology, such as our Concierge Video, represent critical elements in the company's branch transformation growth strategy.

Moving to our electronic security business. Orders were up more than 50% in North America, attributable mostly to activity in the National Bank business. We continue to focus on financial, commercial and national accounts and enterprise customer markets. In addition, we continue to increase our mix of recurring monthly revenue, producing higher margin and increasing enterprise value over time.

Turning to Latin America and Brazil. Total revenue decreased 17% during the quarter, driven by lower volume from elections and financial self-service revenue in Brazil. However, total orders were up more than 20% in the region, driven mostly by financial self-service and security in Brazil and other key countries. And as Andy mentioned, GAS, our recently logical security acquisition in Brazil, has experienced tremendous growth.

We see many opportunities to further expand upon these solutions and service capabilities in geographies outside of Brazil. As Brad mentioned, our margins in this region are under pressure. As a result, we are taking actions to make our manufactured footprint more variable. We are realigning our services support organization to increase span of [ph] control and drive technician efficiencies. We are also taking actions to outsource non-core operations.

In the Asia Pacific region, total revenue for the quarter increased 23%. We experienced order growth in the low-double digits, driven mainly by China, as well as Indonesia. Recently, we secured a win with Bank Mandiri, the largest retail bank in Indonesia, to add more than 1,400 ATMs to their existing fleet. Demand remains strong in Asia Pacific and we expect moderate topline growth for the year in the region.

In EMEA, total revenue for the quarter was relatively flat year-over-year. Total orders were up nearly 30%, driven by wins in key growth markets, particularly Turkey and Saudi Arabia. In addition, we realized higher volume in mature markets such as Belgium and Italy. We recently secured a major win with Unicredit Bank in Italy, consisting of cash dispensers, as well as our most recent line of ATMs, the Flex Performance Series. This reinforces our reputation with strategic customers and demonstrates the value proposition of this new series of advanced-function ATMs.

In terms of our multiyear realignment plan, we have been moving quickly and making good progress with our multiyear actions. Previously, we talked about a savings target of $100 million to $150 million to be completed by the end of 2014, with total savings fully realized by the end of 2015. In the meantime, we have already identified $150 million of targeted savings, and we are accelerating the timing and underpinning of our cost-saving efforts moving forward. The global setup we implemented at the beginning of the year is delivering improved accountability, operational rigor and accelerated cost reduction activities. Most importantly, we are stabilizing and prepared to transform our business. We continue to look for new ways to accelerate our existing projects, build additional capacity, to invest in the business and to identify new initiatives to drive growth.

We are also focused on driving working capital improvements. One key area is inventory. During the quarter, you will notice we have increase our inventory turns. We have initiated a number of projects geared towards significantly reducing manufacturing inventory, as well as finished goods.

In conclusion, we are making progress and remain committed to the expectations we have set forth. Andy has hit the ground running and has quickly provided us with some additional valuable insights, which are accelerating our operational improvement efforts. I remain confident in our ability, along with Brad and the rest of the leadership team, to accelerate an effective transformation that will deliver value for our shareholders.

With that, I'll turn the call back to John for some closing remarks.

John D. Kristoff

Thanks, George. One additional sidenote. We will be communicating more details on our turnaround plan during our planned Investor Day in November. We will communicate specific details regarding that event at a future date. And with that, I'd like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go to Gil Luria with Wedbush Securities.

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

Would you mind for the 2013 guidance to give us some of the piece parts for growth by business, ATM, security and voting? And would the improvements in the back half of the year for margins, are they going to come from more from gross margin or operating margin?

Bradley C. Richardson

It's Brad. That's a very, very good question. As we look at the overall guidance for the full year, minus 5% to minus 7%, certainly we're expecting that the security side of the business, again, as George and Andy spoke to, we're expecting a positive growth in the neighborhood of 1% to 3% there. You asked also about our election systems and lottery and just again, where those businesses are. From a timing standpoint, they're actually going to be down year-over-year, call it, a percentage and point -- percentage point impact on overall revenue performance. And so that would give the financial self-service business, again, for the reasons that we've articulated, in particular kind of here in North America down 6% to 7%. So those are the pieces that actually make up the overall revenue performance expectation of minus 5% to minus 7%. Your point in terms of really what drives the overall back half earnings performance of the company, certainly, as you've seen historically, looking at the various geographic regions, our EMEA business is slightly back-end loaded but relatively stable. Our Asia Pacific business, again, has been a relatively stable, even contributor throughout the year. But we do see typically our Latin America business, both including -- or in our Latin America business is typically back-end loaded and we have the order activity in place to support that. Our Brazil business again is back-end loaded this year just given the timing of some of the tenders. And we've only put in our forecast, what we have booked, if you will, at this point. So really what's driving the second half performance is Latin America and Brazil and a slight uptick in the performance of our North American business.

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

Got it. And then in terms of your dividend, are you given the cash needs this year? Are you contemplating reducing the dividend or are you comfortable continuing to -- your 60-year streak and increasing it, how long if you needed to borrow in order to do that, would you be willing to do that for a year or 2 years in order to continue that streak?

Bradley C. Richardson

Yes, let me -- I'll comment here and I'm going to let Andy also kind of give his overall philosophy on that. What I would say is clearly, our dividend policy, if you will, is evaluated -- and our performance is evaluated over a multiyear period. Certainly, if you look at this year, there is a significant drain on our cash resources for the onetime items. But if you back those out, the overall underlying cash flow, free cash flow the company is somewhere between $70 million and $100 million. So still positive and sufficient to cover our dividend. We have also, though, and I'm very pleased that we've taken action to restructure the balance sheet, which strengthens our liquidity. We've also taken the actions on our pension plan, which while difficult for our associates, again, provides us with much, a much stronger balance sheet to support the company as we maneuver through a period where, again, we've got the regulatory draws but we also have the restructuring that we're doing. All of these are designed to take cost out of the company and return the company to growth. And that's what's ultimately going to allow us to sustain the dividend is by making meaningful improvement in our cost structure in order to improve our margins, improve our cash generation as we go forward and put us in a position where we have the cash to pay the dividend and reinvest for growth.

Andreas Walter Mattes

Let me just add one thing to that. We realize the importance of the dividend for investor base [ph], and also believe that we want to make sure that our investors participate in the success that the company has going forward. Brad just pointed out all the onetime effect that we -- that put pressure on our P&L this year. But the midterm perspective for the company, we're optimistic. We believe the actions we are taking will increase our free cash flow going forward and should underpin our dividend policy going forward as well.

Operator

Matt Summerville, KeyBanc.

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

With a $150 million plus you're talking about and have identified in terms of cost savings, can you guys walk through kind of the cadence of how that should roll through your P&L? Meaning, how much you should expect to realize in '13, '14 and '15? And then, Andy, is the game plan still to reinvest about half of that and let the other half drop to the bottom line?

Andreas Walter Mattes

So Matt, as we had talked about earlier, we anticipate about $60 million of that rolling through our P&L and you can see that reflected on our second half performance. As we...

Bradley C. Richardson

$60 million in this year, George.

George S. Mayes

This year, 2013. As we develop our perspective for 2014, we would have a view that we would have in the range between another $40 million to $50 million run through the P&L under 2014 as we accelerate our projects going forward, with the total $150 million being -- coming to fruition in 2015, as we had talked about earlier.

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

And then the second part of that question, Andy, about half of it dropped at the bottom line.

Andreas Walter Mattes

Yes, that's still our objective.

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

Okay. And then I guess just -- in terms of, Brad, you mentioned some Brazilian service contracts, can you sort of let [ph] out that issue, what's going on there?

Bradley C. Richardson

Yes, there were 2 specific contracts that we have in Brazil that were relatively new contracts to the company. The performance under those contracts, certainly in terms of the number of calls that it take to -- taken to service those contracts has been above our expectations. So we have intervened at this juncture to work with our end customers, to adjust those contracts from a commercial standpoint and put that behind us here in the first half of the year.

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

Okay. And then just one follow-up. In terms of small bank spend in the U.S., I guess how are you guys thinking about an uptick there heading into '14 around the time that Microsoft ends support for XP. Do you do think it will be material? And do you think that will result in more proactive discussions on deposit automation and/or branch transformation among that customer base?

Andreas Walter Mattes

Matt, let me start. The good news is the discussions are starting. So yes, we see people contemplating investment going forward. The trigger point where these discussions translate into additional orders, that's -- we're still waiting for that to kick in. The Windows upgrade provides somewhat of an opportunity. But then again, we also need to see how actively the customer base is going to embrace it and how rapidly they're going to upgrade their systems.

Bradley C. Richardson

Matt, let me just kind of add to that point in terms of just the expectations as we go into 2014. You may recall that again, as we went through 2012, the order activity in the regional bank space came down throughout the year following the ADA PCI compliance-related spending and we hit bottom in the third quarter of 2012. We saw an uptick in the fourth quarter of last year, which again, that was the basis for our plan and the basis for our initial thinking in terms of how the company would perform. But since the fourth quarter, we've seen in the first 2 quarters of this year the regional bank spend going back to kind of that third quarter last year of spend. So it's been flat, but at a flat, relatively low level. And as we've built out our expectations for the rest of the year, we've assumed that, that flat trend will continue.

Operator

Paul Coster, JP Morgan.

Paul Coster - JP Morgan Chase & Co, Research Division

I've got 3 quick ones. Actually, on this point of the orders that you've seen, I kind of got the impression early on in the narratives that the orders were picking up, but you wouldn't see the revenue benefit until next year. Now I'm not sure what I heard on the order side. And even if it is picking up, why is there such a lag between the orders and the revenue?

Bradley C. Richardson

Well, specifically, I mean, what you heard and I was commenting to Matt's question on the regional bank space. But we have orders that have clearly picked up in Latin America, Brazil. Our order activity is good in Asia Pacific and also in the EMEA region. And those all are providing, again, the backlog, if you will, in order to generate the sequential improvement that we see here in the third and fourth quarters. But I think it's fair to say that again, in the North America business, in particular on the regional banks space, that activity is, again, relatively flat.

Paul Coster - JP Morgan Chase & Co, Research Division

And why is there a lag, though, in the international business? I'm supposed to reason [ph], but I'm just curious, that's all.

Bradley C. Richardson

Well, the lag, typically, is a 6-month lag, but it can turn out even longer. For example, in some of our activity in India, where there's a very, very long cycles from the time that we get our orders to the time that we install, we got very, very large orders and then they revenue over multi-quarters.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. The second question has to with Andy's statement about turning the service delivery into service business. What does that mean?

Andreas Walter Mattes

Let me start with, we're doing a lot of things in our services business for our customers, but we're kind of doing them just in a fulfillment mode. We got to go through on saying, what is the type of service that we need to do to support our products and our solutions. What is the on-top service that we're providing. What's the value of those on-top solutions? And are we getting paid by our customers for the service that we do provide? And if we were to commit to these on-top servicers and if we were to commit to better SLAs, what would be a premium that a customer would be willing to pay us? And right now, we're doing a more case-by-case approach to it. We're not having that as standardized and as transparent as one would like to do this. And we believe given the high marks that we get for our service business, there's actually upside as we can continue to upsell our service offering and then get reimbursed from our customers for doing so.

Paul Coster - JP Morgan Chase & Co, Research Division

All right. Okay. And then so this brings me to the third question, which is, Andy pretty wisely suggested this is going to take 2 to 3 years to turn this business around. What are we actually talking about as the end state here? Is it just to get us back on profitable growth? Or is it also a new strategic kind of direction?

Andreas Walter Mattes

This is day 45 on the job. So do me the favor, give me my 100 days to work through the strategy. We're taking a crawl, walk, run approach. We're starting with the absolute, no regret, must-do things right now. We will pick up speed as we go through the second half of this year and into next year, and then we'll be a more aggressive going into the out year. And that's why John has already mentioned that we would like to do an Investors Call with all of you and an Analyst Meeting in November, because by then, we should be in a position to better articulate the strategies, the building blocks, the timeline and the expectations that you could have for our the company.

Operator

Jeff Kessler, Imperial Capital.

Jeffrey T. Kessler - Imperial Capital, LLC

First question is, with regard to the $150 million of savings, you've talked about approximately 50% of it falling to the bottom line over a period of time, over the years, as you specified. But could you talk about what is it going to -- what are the costs you've -- what are the costs involved in getting to those savings that will also hit the P&L? You've enunciated some of them with regard to the pension plan, but what other costs should we expect to see hit against that $150 million as we progress through the several year period?

Bradley C. Richardson

I think if you look at what we've identified for the pension plan that there's an impact on the pension plan somewhere and you can see this in the overall full year guidance of between $0.40 to $0.72 a share, and that clearly is dependent upon the participation rate, which we should have a better handle on in the second half of this year. And then clearly, our ongoing restructuring, we expect somewhere in the neighborhood of $0.30 to $0.35, or to be precise, $0.27 to $0.35, which you see in our guidance. So the heavy lifting, if you will, in terms of the restructuring, the pension and the associated costs there are being incurred here in 2013 and we should see, again, the flow-through and the benefit of those. As George I mentioned, some coming through already, but a big impact as we move forward beyond 2013.

Jeffrey T. Kessler - Imperial Capital, LLC

Okay. One question on your security industry. It looks like electronic security orders were up significantly. In that -- in the backlog that you were building, number one, what is the composition? Is this 90% financial? Or if it is not, what other verticals are beginning to show up as wins for you in electronic security? And number two, what -- is the recurring revenue composition of that backlog increasing as a percentage of the total wins as well? In other words, I'm wanting to see whether or not your recurring revenue percentage when we talk 2 or 3 years from now, is going to be higher in electronic security than it is now?

George S. Mayes

Yes, so I think the questions that you raise are really a point of excitement for us. As we look at our book, we see that the split between the financials and the commercials accounts are about 50/50. And so we do see growth in the commercial space, which is one of our key strategy in terms of diversifying our electronic security business. Additionally, in terms of recurring monthly revenue, we see that growing about 10% year-over-year. And so as you know, we just launched the initiative and have been investing pretty heavily in terms of driving our organic growth. And so in the future, we believe that you'll see the kind of incremental recurring monthly revenue that we've been talking about.

Jeffrey T. Kessler - Imperial Capital, LLC

Okay. You've talked -- and actually, you were just asked by, I guess, Paul Coster with regard to how -- what is the comp -- what do you look for in terms of getting paid for your service on the financial side. I'm going to ask the same question on the security side. A couple of your competitors have become very, very, very focused on even walking away from business that doesn't pay correctly in terms of not just -- in terms of the service side with regard to security. Are you also moving in that direction to try to not just get the recurring revenue up to get your margins up, but to make sure that your margins on the installation -- on the product and installation business make sense for you.

George S. Mayes

Yes, our view is as we look at our ES [ph] portfolio, we want to be strategic and disciplined in terms of taking business. We want to make sure that the margins are enhancing or accretive to our current margin book. And so we have walked away from some enterprise deals that were not accretive and we'll continue to be disciplined as we go forward as we grow our business.

Operator

[Operator Instructions] And we'll go to Glenn Mattson with Sidoti.

Glenn Mattson - Sidoti & Company, LLC

In the past, you talked about making kind of -- making acquisitions in the near term or medium term here, but would you say that's been put off for a little while here?

Andreas Walter Mattes

Two answers. Number 1, I go back to my crawl, walk, run approach. First, we got to get the rigor, the execution and the metrics around our business so that we feel comfortable that we can grow our business organically. Second, having said that, of course, we keep our eyes open for opportunities that cross our desks. And like every tech company, we're continuously evaluating scenarios that could be accretive to our overall business case.

Glenn Mattson - Sidoti & Company, LLC

Okay. And then just maybe a little more color on Europe. I mean I guess, Italy ticked up, and what other comments can you make about the rest of the continent?

George S. Mayes

In terms of -- the good news about EMEA, I think, as you know, 2 years ago, we were struggling to get traction in that business. Through our recent cost reduction efforts, we've been able to stabilize that business and return to profitability. One of the bright spots that we see is our business in Turkey, where we continue to leverage our Altus acquisition in terms of service and we continue to get wind in the financial regions. And so overall, I think that's a big success for us.

Operator

Justin Hughes, Philadelphia Financial.

James Justin Hughes - Philadelphia Financial Management of San Francisco, LLC

I just wanted to talk about sort of the cash outlays because you've taken a number of charges, but you haven't actually made the payments yet. So if I can add up the $48 million to DOJ, the class-action settlement, the payments on your early retirement plan, plus your repatriating capital from overseas, I get to about $150 million of cash that will be going out looks like in the next kind of 12 months of onetime nature. Are there any cash requirements on your debt covenants? And can you just refresh us on what your debt covenants are based upon?

Bradley C. Richardson

Yes, I can do that. And just, I think where your math went a little awry there, and I'll just recap it for you. Certainly, the FCPA, the $48 million, again there's a question of timing. But assuming that, that goes out the door this year to settle that matter, $17.5 million for the derivative class-action lawsuit, we have the cash taxes of roughly $20 million for repatriation and probably another $10 million or so in terms of cash restructuring cost. Those add up to $100 million. The pension that you referred to, actually that comes out of the overall trust. Those assets and those decisions are secured by the assets in the pension plan, which again I'll reiterate, the underfunded status of that plan at the end of 2012 was $150 million underfunded and with the actions we've taken in terms of freezing will bring that status down to about $50 million underfunded. But those -- again, that $40 million that you heard, that you quoted with those funds would come out of the trust, the pension assets. And so it will not impact the free cash flow of the corporation.

James Justin Hughes - Philadelphia Financial Management of San Francisco, LLC

Okay. Is there a cash requirement on your debt covenants or what are your debt covenants based on?

Bradley C. Richardson

So really our debt covenants are based upon 2 factors. EBIT-to-net interest, and when I say net interest, meaning we take into account, obviously, the interest expense, but we also credit against that the interest income. And if just you just look at our disclosures on Page 5 of the earnings release, you can see that the interest expense and the interest income about offset each other. So the EBIT-to-net interest is not an issue again because of the net interest is fairly offsetting interest expense versus interest income. The other covenants that we have is a net debt to capital, which again we're allowed to credit the cash against our debt. And so that has to be less than 50% and you can see from, again, our disclosures on the slide is that we're well in compliance of that covenant.

James Justin Hughes - Philadelphia Financial Management of San Francisco, LLC

Okay. And then my other question is I believe you've said in the prepared remarks that you're using a higher discount rate on your pension liability. What did you change that discount rate from and to?

Bradley C. Richardson

Yes. I mean we'll have to get you the exact discount rates. But certainly from the time that we ended the year to where we are today, I mean there has been roughly about 100 basis points increase in interest rates since that time. We'll get you the exact rate that we've used.

Operator

And that concludes today's question-and-answer session. Mr. Kristoff, I'll turn things over to you for closing remarks.

John D. Kristoff

Thank you, and thank you for joining us this morning. As always, if you have any additional follow-up questions, please feel free to contact myself or Jamie Finefrock directly. Thanks again and have a good day.

Operator

And that concludes today's conference. You may now disconnect.

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