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Diebold, Inc. (NYSE:DBD)

Q2 2011 Earnings Call

July 27, 2011 10:00 am ET

Executives

John Kristoff – VP and Chief Communications Officer

Tom Swidarski – President and CEO

Brad Richardson – EVP and CFO

Analysts

Matt Summerville – KeyBanc Capital Markets

Gil Luria – Wedbush Securities

Grant Keeney – Northcoast Research

Zahid Siddique – Gabelli

Roman Leal – Goldman Sachs

Paul Coster – JPMorgan

Michael Saloio – Sidoti & Company

Operator

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

John Kristoff

Thanks, Tim. Good morning and thank you for joining us for Diebold’s second quarter conference call. Joining me today are, Tom Swidarski, President and CEO and Brad Richardson, Executive Vice President and CFO.

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. Tom 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 we have restructuring, impairment charges and non-routine income and expenses 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, our results of operations reported today, including prior periods, exclude discontinued operations. Finally, a replay of this conference call will be available later today from our website. And as a reminder, some of the comments today may be considered forward-looking statements. Internal and/or external factors could significantly impact 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 it over to Tom.

Tom Swidarski

Thanks John. Good morning, everyone. Thank you for joining our call today. We are pleased to report a solid second quarter with better than expected results in several key areas of the company. Growth continues in North America particularly in the U.S. regional bank space, driven by strong demand for deposit automation and new technology needed to meet pending regulatory and industry compliance standards. We also drove operational progress in EMEA during the quarter and are on track to reach a breakeven run rate in the region by year end.

In addition, during the quarter some revenue came in earlier than anticipated helping to reduce the heavy second half of our forecast. Increased order activity in North America continues to drive the business on a macro level. In fact, our financial self service product order backlog in North America is up 75% from last year and is now comparable to levels we had prior to the financial downturn.

Importantly, much of this growth is occurring in the regional bank space, where financial self service product orders grew 180% in the quarter. This is an increase from the growth in product orders we experienced in the first quarter of this year and fourth quarter of last year, which were up 90% and 150% respectively, illustrating the continued momentum in this segment. Given this continued strength in our North America financial self service business we have increased confidence in our outlook for the remainder of the year.

Let’s now take a closer look at our financial results in North America. During the quarter, total revenue increased 5%, while overall product and service orders grew about 14% in the region. Looking at just product orders for financial self service in this region, we saw an increase of around 18%. Demand for deposit automations and need to meet new ADA requirements early next year and ongoing PCI compliance once again fueled momentum in the regional space during the quarter.

These demands are creating a level of complexity that is driving more institutions to adopt an integrated services approach. This enables them to meet regulatory requirements and offer their customers the latest technology without investing a great deal of capital. This environment has resulted in another record quarter for our integrated services business. The company signed new IS contracts during the quarter valued at more than $75 million representing a threefold increase over the prior year period.

One such example we announced during the quarter was with First National Bank of Pennsylvania, where we are providing a variety of product and technological upgrades through integrated services. The bank chose Diebold to help expand its consumer banking options and enhance security by replacing 150 ATMs with Opteva and upgrading an additional 100 ATMs adding deposit automations to nearly one third of the bank’s fleet.

Another U.S. regional customer who has signed an integrated services agreement with us during the quarter was Teachers Credit Union. We are helping TCU implement new technologies and services, including ATM upgrades for deposit automation, monitoring and security that will enhance the Credit Union’s operational efficiencies and improve convenience for its members. We now have more than 500 customers in the United States that are leveraging our deposit automation technology.

In summary, we are very optimistic regarding the state of the North American financial self service market and our strong competitive position. As our large backlog in North America begins to convert to revenue we expect a significant uptick in operating profit for the second half of 2011. Our brand is the strongest and we have an unmatched service capability. As such, North America will serve as a primary catalyst for earnings growth in the second half of the year.

Now looking at our security business, revenue was down 1% during the quarter while orders fell 2%. These results were disappointing. As we were expecting to see a greater rate of recovery this year particularly in the bank branch space. It’s now clear that the security market for branches will remain distressed into 2012. As a result, we have reduced our full year revenue outlook for the security business.

However, we continue to make operational progress particularly from a cost perspective and raising our profile outside the financial market in enterprise security. For example, last week we announced we are managing the integration of a complex security software system for the new World Trade Center’s site in New York. This is in addition to the other work we are doing in terms of securing the construction site and Tower 4 at the World Trade Center. Diebold’s integration efforts will connect an array of system to the security command center via single interface giving operators unified control and views of the entire site.

Diebold will integrate security among 11 locations including five high right buildings, the World Trade Center transportation hub, the National September 11 Memorial and several other critical infrastructure facilities. We have executed well on our diversification strategies as we’ve gained positive traction in the enterprise security area with high profile integration projects such as these. However, creating overall top line growth in this segment continues to be a challenge as the bank branch market for security remains weak. We illustrate this point while our enterprise security revenue grew more than 20% during the quarter. Our overall security revenue decreased slightly.

To generate top line growth in the security business moving forward we’ve begun a number of strategic initiatives and supporting organizational changes. Our goal is to better leverage our enterprise security expertise in the financial market. Historically, our focus in financials have been on the branch with an emphasis on product sales as new branch construction is expected to be flat in the next several years we are shifting our focus to enterprise solutions, which are more oriented towards services.

As security systems have become increasingly complex financial institutions are showing more interest in outsourcing this area of their operations. Particularly, as it relates to monitoring, services and software. To support this strategy we’ve made some significant changes in our U.S. financial sales organization. We moved some of our top enterprise security systems experts over to the financial group as specialists to support our sales efforts to financial institutions. In addition, we’ve created an integrated services business for security modeled after our successful IS efforts on the ATM side.

I have a lot of confidence in the leadership we have in place to direct this effort and our team’s ability to deliver. This is evidenced by the $450 million in ATM integrated services total contract value that we generated over the past five years. Given the lengthy sales cycle inherent with the IS business we anticipate seeing some initial top line impact from these efforts in mid 2012. In addition to the shift in sales focus, we are pursuing other means to effectively grow the security business for the long-term including increased activity on the M&A front.

Now moving to EMEA, revenue increased significantly during the quarter up more than 30% as some large deals in Africa and Eastern Europe had a positive impact. Orders for products and services were down 3% in the period. This decrease is largely due to timing as orders in EMEA were up 42% in the first quarter and 16% year to date. Despite current economic concerns in Western Europe the overall market seems to be fairly stable with France and Italy having turned in solid results for us.

As a whole Africa, the Middle East and Eastern European market continue to show some growth. In Russia, we’ve made some gradual progress to rebuilding our sales and service operation in wake of the FCPA review. During the second quarter, we appointed a new General Manager for Russia who has extensive background in the global IT industry. This is a critical first step towards reestablishing our presence in that market and provides us with the leadership that will be necessary to succeed and grow over the long-term.

During the quarter, we also made progress in our reengineering initiatives in the region. We continue to consolidate and centralize administrative work in our European shared services center. We also entered some distributive relationships in several non-critical markets. And we continue to drive improvement in our supply chain and manufacturing.

Overall, we’ve identified $8 million in cost reductions that will be realized in 2011. As a result, well we lost more than $10 million in EMEA in the first quarter our losses in the second quarter were trim by over 50% sequentially. This puts us on track to hit our target of a breakeven run rate in EMEA as we exit the year.

Obviously our first priority is stabilizing the EMEA business in the near term however we will continue to build our services infrastructure throughout the region and invest in key growth markets to improve our competitive position over the long-term. In Latin America and Brazil, orders and revenues both declined about 30% during the quarter excluding election systems and lottery sales however orders and revenue declined 15% and 7% respectively.

As we’ve previously discussed, our business in Latin America and Brazil is particularly backend loaded in 2011 driven by a concentration of large orders. In Brazil, we received one of these expected orders during the quarter. In July, we received three additional sizeable orders in the region. We now have orders for several 1000 ATMs in hand as a result we have greater confidence in our forecast for the remainder of the year. We were also recently named Best Information Technology Company in our industry segment by Exame Magazine. This is the fourth time Diebold Brazil has been recognized as the best IT Company in Brazil.

Last month in Sao Paulo, I attended the 2011 CIAB Conference, which is the most important Financial and Information Technology Trade Show in Brazil and one of the largest in the world. While at CIAB, I spent time with Senior Executives from (Inaudible) and Banco Santander. The later a customer was in expanding global reach. With all three seeking a partner as an organization with a passion for solving customer problems and a proven track record of delivering innovated solutions that address emerging needs.

This is at the heart of what Diebold does. And gives me continued confidence at the capabilities of our Brazilian operation both from a technology and services perspective will allow us to lead the market and continue to grow in Brazil as we move forward through the future. The market with the rest of Latin America also remains very active. During the quarter, we won major deals in Mexico, Columbia, Venezuela and also made solid inroads in Peru a country in which we are currently under penetrated. Services growth in this region is also been particularly strong.

Now looking at Asia Pacific, revenue increased 6% during the quarter while orders for products and services jumped 18%. We exceeded our Asia order entry forecast for the quarter as we were awarded one of the large anticipated orders from China. And some business in India and South East Asia was awarded to us earlier than anticipated. In fact our order backlog for the region is up nearly 50% from the prior year near an all time high.

Given our strong second quarter order entry and backlog I remain confident in our ability to deliver for the full year in the region. As I mentioned, India was particularly strong for us in the quarter as we continue to grow our presence in that key market. In May, we announced an agreement with State Bank of India to install 1700 ATMs these units are specifically designed for India to optimize power consumption and the total cost of ownership. Deposit automation will be enabled by our Opteva 328 cash recycling ATM, which has a high capacity cash deposit and recycling terminal with a compact footprint. In addition, our growing outsourcing business in India continues to gain momentum as we signed multiyear managed services contracts for nearly 10,000 ATMs during the quarter.

Diebold is the leader in managed ATM services in India with nearly 40% of the country’s outsourced ATM market. Due to the importance of Asia Pacific and the tremendous growth opportunities the region provides I’m pleased with the significant strides we’ve made in establishing our services business. We remain committed to focusing on our services offerings and disciplined cost management, which we believe will be key to our continued success in Asia. From an operational perspective we continue to execute to what the goals we established in our smart business 300 initiative. Also the Japan supply chain issue we first reported last quarter has been resolved and the financial impact to the year has been largely mitigated. This involves a great deal of work from a dedicated team of professionals in our procurement organization. Having managed through this successful reduces some risk from our forecast as we look to the remainder of 2011.

And given the earlier than anticipated second quarter revenue we generated as well as our growing order backlog and in financial self service we gained more confidence in our outlook and are reaffirming our prior guidance of $2 to $2.20 per share.

So to summarize, we feel good about the opportunities out there in the markets we serve and I feel we have a right foundation to build upon. Around the world, Diebold is proving everyday that we have exactly what it takes to execute on our business and expand our customer relationships. Our expanding offering of services, coupled with innovative, reliable technology and our ability to consistently deliver on our commitments to customers, gives me confidence that we will meet our strategic objectives. With that, I will turn the call over to Brad.

Brad Richardson

Thanks Tom, and good morning everyone. Before we get into the financials, I will provide an update on our progress in EMEA restructuring, our compliance efforts and the second half seasonality of our forecast, which has changed slightly. Regarding our restructuring efforts in EMEA we are executing on our plans across the region.

As Tom indicated, we have identified $8 million in cost reductions that will be realized in 2011. This will be accomplished through core country rationalization, lower manufacturing and logistics cost and improved administrative efficiencies through leveraging our shared services infrastructure.

In addition, we have identified other actions during the quarter that will result in further savings in 2012. As a result, we are raising our restructuring estimates for the full year. We are confident that the actions we are taking are beginning to produce visible results. As Tom also mentioned, we were able to reduce our losses in the region by half in the second quarter compared with the first quarter. In fact, we showed a slight profit for the month of June on strong year-over-year revenue growth. We have a long way to go before we are consistently profitable in EMEA on a month-to-month basis; however, I am encouraged by the early results we have generated and even more confident that we will achieve our target of reaching a breakeven run rate by year end.

In regards to our compliance efforts during the quarter, our global FCPA compliance review remains on schedule with no material development since our previous earnings call. We still expect the FCPA review will be completed by year end. FCPA related costs for the quarter were approximately $4 million down from $6 million in the first quarter of 2011 and the fourth quarter of 2010.

Also on the compliance front, during the quarter we brought onboard a Chief Compliance Officer as part of our effort to ensure our program is highly effective according to industry best practices and global government standards. Regarding the seasonality of our 2011 forecast, on slide 16 as we previously indicated there are several factors that have led to a very heavy second half of the year from an earnings perspective. However, some business closed earlier than originally forecasted during the quarter, which has reduced some of the backend loaded nature of our forecast. We had previously expected 75% of earnings to come in the second half of the year. Now we expect approximately two-thirds of our 2011 EPS to occur in the second half of the year with more profit coming in the fourth quarter than the third quarter. The change in phase between the first half and second half is important as it reduces some of the risks associated with our previous forecast.

Now to review our financial results for the quarter. Turning to slide seven, total revenue was essentially flat from the second quarter of 2010 with 5% positive impact from currency. Products revenue declined 8.5%, while service revenue increased to 6.2%. The decrease in product revenue is primarily the result of lower election and lottery systems revenue in Brazil, which is expected to revenue in the third and fourth quarters of this year, compared with the second and third quarters in 2010. Excluding Brazil elections and lottery, product revenue would have increased 6%.

Looking at our financial self service business on slide 18, second quarter revenue increased 9% from the second quarter 2010, growth which primarily driven by strength in North America and EMEA. In the security business on slide 19, second quarter revenue declined 1% on the same period in the previous year. Growth in services revenue was more than offset by a drop in product-related revenue. As Tom mentioned, the market for bank branch security equipment has not recovered as we had anticipated, which is negatively impacting our product revenue. However, service revenue continues to grow driven by the enterprise security segment, which grew by more than 20% during the quarter.

Looking at slide 20, the total gross margin for the second quarter was down 0.8 percentage points, compared with the second quarter of 2010. Both product and service gross margins were also down by 0.8 percentage point for the quarter. Product margin improvement in North America was offset by decreases in the international operations led by EMEA. The decrease in service gross margin is primarily due to a difficult comparison to the prior year period when we benefited from a vehicle fleet rebate and some other items during the quarter that resulted in a higher than normal service gross margin.

In addition, we expect increased fuel cost to be ahead for the remainder of the year. As a remainder every $0.10 movement in the retail price of gasoline in the U.S. increases our annual expense by approximately $700,000. Despite these headwinds we still anticipate a slight improvement in the service gross margin for the year.

Moving now to non-GAAP operative expense, that’s highlighted on slide 21 in the second quarter operating expense as a percentage of revenue with 20.4%. Sequentially, however, OpEx decreased 0.6 percentage points from the first quarter and we expect OpEx for the second half of the year to be in the mid 17% range as we anticipate significantly higher revenue towards the end of the year. Now turning to slide 22, non-GAAP operating margin in the second quarter with 5.6% we expect full year operating margin to be around 7%.

Turning to the EPS reconciliation table on slide 23 the non-GAAP EPS move from $0.53 per share in the second quarter of 2010 to $0.44 per share in the current quarter. Our non-GAAP tax rate declined from 28.7% in the prior period to 25% in the current quarter. We still expect our full year tax rate to be approximately 28%.

Turning to slide 24, free cash use for the quarter was $22.6 million compared with free cash flow of $22.9 million in the second quarter of 2010. Negative cash flow versus the prior year period is primarily the result of two factors. First, we had approximately $70 million in tax refunds in the second quarter of 2010. Second, as Tom mentioned, we’re at near record backlog levels in North America creating a buildup in inventory to meet delivery schedules for the second half of the year.

As we look at the full year, we anticipate normal seasonality with strong free cash flow later in the year. I remain comfortable that free cash flow will be around $150 million for the full year supported by significantly higher second half earnings, inventory drill [ph] down and a normal pattern of accelerated collections towards the end of the year. In addition to our dividend, we expect share repurchases to be the primary use of cash in 2011. During the second quarter, we have repurchased $1.1 million shares leaving $2.4 million shares on to current board authorization. We still intend to execute on the remaining share repurchase authorization in 2011 barring [ph] any dramatic changes in the business environment or acquisition activity. As Tom mentioned, we are building a pipeline of potential acquisitions targets focused on our current core lines of business.

Looking at slide 25 and 26, DSO increased from the prior year by 4 days, while inventory returns remained the same. The increase in DSO is primarily the result of timing of revenue late in the quarter. Working capital remains a top priority and we anticipate normal seasonal improvements by yearend. As a remainder, each day is worth about $5 million in cash flow.

Turning next to liquidity and net debt on slide 27, net debt was $149.7 million a decrease of $44 million from June 30th 2010. Our net debt-to-capital ratio was 14% at June 30th 2011, compared to 16% in the prior period. We have made substantive reductions in our net debt since 2007 while at the same time returning more than $350 million to shareholders in the form of dividends and share repurchases. Based on our projections for free cash flow we anticipate being in a slight net debt position at yearend.

Also during the quarter, we announced we entered into a $500 million credit facility agreement with certain credit relationship banks. This facility replaces a previous facility of approximately the same amount, which was scheduled to expire in October 2012. The renewal improves existing covenants and includes an all end reduction in borrowing cost of 150 basis points, which represents an annual savings of approximately $5 million at current debt levels. In addition, the unsecured credit facility is for a term of five years and expires June 2016.

Our strong track record of consistent cash flow enabled us to significantly reduce our borrowing cost and improve the length of the term of the facility. In terms of the outlook for 2011 on slide 28, we expect revenue to increase 3% to 5% while financial self service revenue increasing 6% to 9 % and security revenue flat to down 3%. Given our continued aggressive plans in EMEA we have increased our anticipated restructuring charges for 2011 to be in the range of $0.31 to $0.35 per share. We are maintaining our full year non-GAAP EPS guidance in the range of $2 to $2.20 per share.

In conclusion, we are extremely encouraged by the momentum we are seeing in the key North America market particularly in the regional bank space. Our bank balance sheet remained strong and we are seeing operational improvements in Europe and are aggressively addressing our build business challenges there. Also the earlier than anticipated business we closed during the second quarter gives us increased confidence in our forecast for the remainder of 2011. In the intermediate term we remained focused on driving operational improvement and executing strategies in our core businesses to drive return on capital employed for our stated goal of 15%.

We have a great level of confidence on our global team and our ability to deliver value for all of our stake holders. With that I will turn it back to John.

John Kristoff

Thanks Brad. I assume we are ready to open it up for questions now. We just ask each caller to try to limit yourself to two questions initially and then get back in queue so that we have an opportunity to get through everyone’s questions. Thanks. Tim?

Question-and-Answer Session

Operator

(Operator Instructions). And we will go first to Matt Summerville with KeyBanc.

Matt Summerville – KeyBanc Capital Markets

Good morning, couple of questions. First, Tim I think you may be mentioned this but I want to make sure I understand the small bank order book or the regional bank order book in North America that you have now compares to the prior peak how Tom?

Tom Swidarski

In terms of the regional orders that we are basically back to where we were prior to the, what you call the financial economic crises throughout. So in the self service side it’s improved dramatically as you can see by the percentage increases over the last three quarters and sequentially as well.

Matt Summerville – KeyBanc Capital Markets

So, if we look at kind of where your product gross margins back in out the items a little over 25 kind of where they are at in the second as you get into the sweeter spot in that backlog. Do you think your product gross margins have room to move back to where they were pre sort of the financial crises? I guess how are you thinking about your backlog in the margin upside from here?

Tom Swidarski

Yeah, so Matt I think if we just compared North America to North America, I’d say we are going to feel pretty confidence from where they move back to, I think when you mix in the rest of the world particularly the Asia pricing issues where we are at in the EMEA, I think that while we might see some increase in product gross margins. I think it’s going to be muted as a result of folks of regions outside the U.S. and particularly with kind of the Asian influence from a pricing standpoint and given that Asia as you saw from our orders and from the revenue continues to grow that mixes in and impacts that number.

Matt Summerville – KeyBanc Capital Markets

Okay, and then just one final question I’ll get back in queue, you talked about the incremental cost savings that you expected from your efforts in EMEA at $8 million or the total cost savings at $8 million realized in 2011 based on all the actions you are taking (Audio Gap) taking then how much would that tee up to be incrementally realized in 2012?

Tom Swidarski

I think we will be in a much better position the next couple of quarters to give you some better direction on that, I think we have some aggressive plans in EMEA that we are executing again so we feel good about how we are moving down that path. But until we actually realize those and measure that accurately, I think we would wait to give some direction on that, I want more confidence and our ability to deliver it more confidence in our ability to steer here correctly.

Matt Summerville – KeyBanc Capital Markets

Thanks Tom.

Tom Swidarski

You’re welcome.

Operator

And we will go next to Gil Luria with Wedbush Securities.

Gil Luria – Wedbush Securities

Yes, good morning. So it sounds like we are at the end of the July and then given the timeframe between your receiving orders and being able to actualize the revenue and recognize the revenue. It sounds like from your commentary that you have everything you need, you have sold everything you needed, you have gotten the orders you need to give you confidence for results for your guidance for the rest of the year, now it’s just a matter of executing on those orders.

Tom Swidarski

Yeah Gil, I would say that’s very close but we still have work to do here in August relative for the remainder of the year but certainly we’ve taken a lot of risk off the table with the size of the orders we have recognized or realized around the world and certainly July was very critical component of that, we were anticipating that they have been realized. So now some of the risk becomes more of the implementation risk of in the November, December timeframe we have schedules laid out, things happened to those schedules. So I would call it more implementation risk whereas last quarter we were saying well there is a lot more risk associated with what we needed to capture in terms of orders.

Gil Luria – Wedbush Securities

And Tom, my second question is about the fit of your security business, Tom your ATM business is improving, it’s doing very well, it’s your higher margin business certainly the activity of the regionally U.S. banks is encouraging, you are going in spite of what the portfolio assessment you are doing in Europe. But in spite of the U.S. regional banks doing better the security business does not seem to be doing better, three quarters of your business is still banks and they seem to be buying ATMs but not building a lot of branches. How do you see the long-term fit of this business as it disappoints one more year, this is not the first time you’ve had turn around in this business in the past? And why would you want to invest more capital in M&A in this business if it that’s the if the ATM business is really the business that’s really driving the growth overall?

Tom Swidarski

Yeah, fair question Gil. And the one that we have talked a lot about internally, if you look back in the macro level, the pieces of the security market they are very big piece of the security market that are growing fast that we have not necessarily participated in the way we think we can. A lot of the wins that we’ve had that I mentioned in terms of level of sophistication, the World Trade Center is a nice one now because there’s five or six different projects we have there, order entry in the neighborhood of $30 plus million in one particular site needing the kind of sophistication that you bring to the table as a result of what we’ve able to do on the ATM side.

The changes we are making strategically in the security business is one with the recognition that the branch activity right now continues to falter part of that in the regional bank space in result of the capitals we are investing on the ATM side, we had a number of those conversations with folks. So that’s one issue associated with that. The second is our focus of the organization on the security side is both important for the security business as well as the self service business as well. A lot of the activity is pulled through from a security stand point on the ATM. So when we talk about our IS offering, or moving on to the IS side on the bank, what we are talking about is taking the capability that we have in the World Trade Center and brining that back into the banks around the United States and not just focusing on the branch anymore.

Because as you can see we’ve demonstrated outside the financial sector that there is a need for kind of capabilities we have, we’re bringing the expertise back into the financial sector now with a focused effort there. And the individual we have to leave, that was the individual we have to leave the IS on the ATM side, to have pretty big confidence there the other thing I would say, if you look at the security business, 60% of it today is recurring.

So it has the makeup of exactly what we want, what we have not done the last two years successfully is pushed hard enough in the financial sector in the space it’s growing, which is really enterprise IT kinds of capabilities, which we’ve done outside of the financial. So with that we’ve got a very focused effort on this and our expectations are, you can actually grow this faster once we get the branch piece back to a kind of a more normal level. So that’s why it’s both important strategically as well as practically.

Gil Luria – Wedbush Securities

Got it, thank you.

Operator

And we go next to Grant Keeney with Northcoast Research.

Grant Keeney – Northcoast Research

Good morning. Your comments on the environment India on the move to an outsource model. I was wondering if you could provide some color on the competitive environment there and you know your strategy just given that shift to the outsourced model. You know, there are company’s you are competing versus, who just provide only an outsource service or what’s the competitive environment like?

Tom Swidarski

Yeah, Grant, I would say in India, India evolved, when you look at different markets around the world, India evolved maybe differently, since some of the other markets from the gecko [ph], they were very services oriented on the very front end. So fortunately for us that played into kind of our mode of operation which is, maybe less product centric and more holistic services oriented.

So such as we established operations in India, certainly would be the footprint with technology and the product itself, but we begin to develop the services infrastructure that we leverage from Brazil right out of the gate, that gave us some really [ph] experience there. What we’ve seen is the market moving more and more aggressively in that direction, I think we’re well positioned and feel like we have 40% of the market and are the market leader there with some of the biggest banks in that space.

You do however find a unique set of players there and there are some small startup, there are other players in this space that you wouldn’t see anywhere else in the world, that certainly are competitors in that arena. We feel like we’re well positioned there because of our total capability and it ties into our service operation, but we certainly have our eye on a lot of these small competitors that we find ourselves up against in some of these bids?

Grant Keeney – Northcoast Research

Okay, thank you. And then a follow-up on a previous question you talked about the shift towards more of an outsource enterprise security model, I think you mentioned the change in the field for organization there. Do you expect to grow that business organically or are there companies out there you can acquire to enhance that profile?

Tom Swidarski

Yeah, I think I’d answer that both. I think we’ve got the skill set we’ve got name recognition with these kind of contracts we’ve won, likewise, again we are talking about specific niches where our competencies, give us a competitive advantage in these spaces. So when you think back in terms of a financial sector we have a lot of opportunity there because we haven’t been in that space really at all, we’ve been in more of the bank branch space.

So we are talking about taking our competencies back into the banking sector with some of the high end enterprise IT capabilities and there are some marginal players that could add some competencies there for us. So that would be the type of thing we are looking at along with having a broad offering of services, so platforms that offer the capabilities to expand our services offering into that institution becomes important.

So it’s not just alarm monitoring, it now is monitoring energy management consumption kinds of things, it’s now monitoring other sophisticated things that we do on the IT side, the video surveillance kind of capability, biometric entry into remote locations, identity management. Those are the types of sophistication that we are able to do at these high end enterprise pieces that we haven’t focused on in the financial, so I would say it’s both capability within this, the verticals that we’re focused on and secondly it would also be companies that add services capabilities to expand, we’re already offering to someone.

Grant Keeney – Northcoast Research

Thank you, Tom.

Operator

And we’ll take our next question from Zahid Siddique with Gabelli.

Zahid Siddique – Gabelli

Hi, good morning.

Tom Swidarski

Good morning.

Brad Richardson

Good morning.

Zahid Siddique – Gabelli

I have a few questions. The first one is on the debt level, I know the debt has gone up by about $50 million roughly. What was the reason?

Brad Richardson

You’re talking about the debt levels from?

Zahid Siddique – Gabelli

From, I believe, Q2 over Q1.

Brad Richardson

Yeah and really that function of the fact that we had negative free cash flow in the quarter, we had our normal dividend and then we had repurchase 1.1 million shares in the quarter. Again we’re looking at this, Zahid, more from a full year perspective given the backend loading nature of our cash flow.

So as we look at the overall free cash flow for the full year of the $150 million, we look at the dividend that we’re going to be outline plus continued execution on the share repurchase, again we expect that will be in a slight net debt position by the end of the year. So I would encourage you to kind of look at the full year as oppose to just the quarter.

Zahid Siddique – Gabelli

Okay. And then on Brazil election, you’re sort of expecting roughly $100 million for the rest of the year?

Tom Swidarski

Yes.

Brad Richardson

Yes.

Tom Swidarski

Yeah, that’s correct. I think we 100 to 105 in estimate, that includes lottery, but that’s the category, that’s right.

Zahid Siddique – Gabelli

Okay. And then within the, I guess talking about the M&A, one of your competitors is undergoing an acquisition, currently they are adding another leg to their business. And I wanted to get your thoughts on your end, are you satisfied with the portfolio that you have or could you potentially also be looking to diversify?

Tom Swidarski

Zahid, I think our focus is more with to be more focused on adding capabilities for existing businesses that we’re in. And that’s how I would differentiate it and I would also say that ours would be very, maybe more oriented towards services in the software side and the recurring revenue stream of services in the software side of the business. So that’s how I would differentiate it, I don’t think we have any intentions to try and put a completely different vertical within our portfolio, we are pretty happy with where we are at, we see the opportunities, we think are significant, regarding to the spaces we’re in, we need to execute better within those spaces and add and take advantage of the competencies we’ve built. So that’s the direction we would take on the M&A front.

Zahid Siddique – Gabelli

Okay. And also going back to the competitor, we’ve heard that that we’ve been gaining share in North America and Europe, would that mean that you’ve been losing share or is that what’s your take on that?

Tom Swidarski

Well, I mean, I guess I would, for me, this whole share conversation always is brought with a lot of issues, but I would just say, you mentioned North America, if you look at our first North America slide, our regional space was up 183%, or 180% I think in this quarter, we were up 90% the previous quarter, 150%, the prior quarter.

So those are our products level numbers and I put those out there because, I get this question all the time and well to me product isn’t really a big indicator of share, I would have to say that those numbers are significantly higher than anything I’ve seen from anyone else. Again, we’re looking the holistic aspect of recurring revenue streams and services that included in those numbers, but our product numbers are much higher than anyone else’s, when you look at it from just a product standpoint.

We report product and service together, that’s why our overall numbers would look smaller but when you pull product out, you saw that we are up 80% in product alone in North American financial self service, huge numbers.

Zahid Siddique – Gabelli

Sure and just a last real quick one, what was the tax refund, I think you said $20 million, what was it from?

Brad Richardson

And so the tax refund was $70 million that was received in the prior year, and that was really due to some tax planning work that we did as a result of some divestment activity.

Zahid Siddique – Gabelli

Okay and so that was to second quarter of last year, so no refund this quarter?

Brad Richardson

That’s correct.

Zahid Siddique – Gabelli

Okay, thank you so much.

Operator

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

Roman Leal – Goldman Sachs

Hey, everyone this actually Roman Leal. I wanted to ask a little bit more on the market opportunity in India. How big do you see the addressable market there? How many ATMs do you think there are? What percentage of that is outsourced? And do you think this can potentially become as important as Brazil for you?

Tom Swidarski

I think it will take a while to get the levels of Brazil. The market information you have relative to India is sketchy at best, but let’s say there is about 70,000 units that are there. The difference would be, in the India market today, we are focused on outsourcing and we’re building our competencies there and like I indicated we think we have about 40% of that market. It’s going to grow very fast going forward, I mean, in our business there, banks want to deploy faster, then they have internal capabilities too, plus it’s driving the outsourcing capability.

The difference is in Brazil, we’re basically not just an ATM company, we’re an IT company, so we have all sorts of other engagements in these banks that are IT centric providing certain types of technology and even beyond kind of the bank sphere. So it would be, we’d be hard pressed here to say we could get to the level we’re at in Brazil in the next five years, maybe a longer term you can get there.

But right now we want to built our competencies, both in the services software standpoint focused on the ATM space and outsourcing with our capability there, feeds into where the market is going, not everybody is moving there, but a lot of players are. And so managing complex networks and doing that well in getting the scale we need is really what we are focused on. We’ve had some good progress there and I would expect that, we just see continued growth over the long-term in India, each year for the next five to ten years.

Roman Leal – Goldman Sachs

Great. On the security business what makes you confident that, with the sales kind of restructuring and other changes you made there, what makes you confident, that you will start seeing some top line impact in mid 2012. Is that more of a pipeline, a comment or something else there? And also I understand that the new bank crisis that’s remain weak. But what’s the natural, or is there a natural upgrade cycle to current security systems that kind of encourage banks to rethink their, the security systems and maybe even open the door for you to introduce these new value added services there?

Tom Swidarski

Yeah that kind of, almost the answer I would be playing back to relative to the importance of this space. So first of all, in terms of the organization, we’ve taken the individual that help to create our IS space, IS business on the ATM side to lead our sales effort comprehensively on the security side. So as an individual Greg Steffy, I think many of you have met him, and he has the ability to really take a complete solution and provide it to the marketplace.

So, integrated services becomes a key aspect to this, the second piece of that is not only his leadership, but the dedicated resources that we’ve now put under him as well. So we now have security specialists that are focusing on the space, much like we do ATM specialists that can go very deep on these subjects, because security is no longer a very simple topic, it’s a very complex topic and the IT capabilities are required. So as such what we had developed actually outside of financial, which is the reason why the World Trade Center and UN and these other big complex facilities that need deep IT capabilities use us, is the reason we are taking that organization and focusing back on financial.

And as we do that, that allows us really to get them into the IT world, relative to security where our skilled and competencies differentiate us from someone using, VCRs or a simple method that they still use in many institutions today, relative to video surveillance and tapes and all sorts of things that are inoculated. But there is not an ability to migrate them, we now believe that we got ability to do that, the markets moving in that direction we are now putting the resource against that with the right leadership and dedication.

So we feel pretty good about our ability to do that it’s evidenced by when we put the focus on the non-bank space, we’ve been able to generate the kinds of wins that are quite frankly taken the industry by surprise. So the whole World Trade Center now is got five major projects that Diebold has won in that space, the most recent one, the situation awareness one ties in 11 different facilities, all from different vendors and suppliers to one location this could be monitored all through the software and capabilities that we developed in the design site. Eventually we will be looking to monitor great services from that entire operation, so that’s why I’ve got confidence in our ability to do this.

Roman Leal – Goldman Sachs

Great, thank you.

Operator

And let’s take our next question from Paul Coster with JPMorgan.

Paul Coster – JPMorgan

Thank you, most of my questions have been answered but I do want to talk a little bit longer on this security service question and the allocation of resources. So is it mean that you are going to deemphasize the resource that is allocated to the non-financial services sector. And in terms of your sort of expectation of this demand being in existence in the financial sector, have you actually got a couple of kind of wins under your belt that have given you confidence that the demand pull through there and it’s not just associated with having the right people allocated to the space?

Tom Swidarski

Yeah, good question. And yeah, I would say it is going to force us to, we are taking some resource from some of the non-financial sectors where we have not seen the profitability that we were expecting into the ATM space. So part of it has to do with growth part of that to do with profitability expectations long-term. So as we said on the front end we went in to take a look at security in a lot of these non-financial sectors we are going to analyze both growth rates and our ability to deliver the kind of profitability that would be a credit for the company.

As we have looked at that and then also looked at the financial side we have two customers I would say in the top 25 in the United States where we have done significant complex IT security projects for, which has given us a lot of confidence as we’ve gotten in there, in terms of the opportunity because several others have come to us and asked similar type questions. So we see a path to actually taking over the infrastructure of one of the top 25 banks in the United States in terms of running their security infrastructure from the command center all the way to all the technology out to all of the folks in their facilities. So yeah, we have a lot of confidence in it, we have a few wins that are under our belt, we got a long way to go but that’s why we are reallocating resources back.

And it’s the space where we know how to climb around in the financial institution, we know where to go, we already know the IT folks. So for me its focused depth with the right competencies will allow us to get in there to generate the kind of growth we have. And at some point as the bank branch activities take place we are going to pick up again. It’s just has not taken place now but certainly a lot of banks have talked to us about that. But we can’t wait for that, that’s why we are focused a lot of taking our enterprise IT expertise back in the large scale projects.

Paul Coster – JPMorgan

Do you see some of the quiet of carrying sales people as fungible between the integrated services business and the enterprise security business.

Tom Swidarski

I would say they are fungible from the standpoint of the security technical expertise you need works across the various industries. What is not fungible is your brand. And what is not fungible is the longer the sales cycle. So for us being in spaces we are very comfortable with and have a reputation in allows you to move down this path very quickly, and that’s the goal here.

Paul Coster – JPMorgan

Okay, thank you.

Operator

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

Matt Summerville – KeyBanc Capital Markets

A couple of follow-up questions, can you guys quantify the magnitude of what we will call a pull forward that you think you experienced from July into June?

Tom Swidarski

I’m looking (Inaudible) I don’t know if I can…

Brad Richardson

No, I don’t think so, Matt.

Matt Summerville – KeyBanc Capital Markets

Okay, and then Tom to one of my earlier questions you talked a little bit about pricing calling out Asia, can you just do kind of a quick walk around the major regions and talk about what you are seeing from a pricing standpoint?

Tom Swidarski

Sure, since you mentioned Asia; let me comment there first. Asia certainly from our vantage point has the most pricing pressure on us because you have most players there and the size of the opportunities also creates pricing pressure. When I look at the other regions of the world if you went in, say Latin America and Brazil I would say it’s kind of consistent that has been, United States has been relatively consistent. And when you look at Europe, Middle East and Africa you would say more or less consistent again the one common theme across all of this would be the big opportunities attract a lot of attention and have a strategic procurement folks involved by the very nature of having more pricing pressure than you do on some of the smaller opportunities, that’s why as the regional banks has kind of begun to do activity that with our reputation and closeness to them. It really gives us a nice competitive advantage with the service infrastructure. Outside of that, it is the major banks across the world it is very price competitive.

Matt Summerville – KeyBanc Capital Markets

Okay, that’s actually all I have. Thanks Tom.

Tom Swidarski

You’re welcome.

Operator

And we will take our next question from Michael Saloio with Sidoti & Company.

Michael Saloio – Sidoti & Company

Hi, thanks for taking my question. Can you guys hear me?

Tom Swidarski

Yes.

Brad Richardson

Yes.

Michael Saloio – Sidoti & Company

Okay. Could you just maybe summarize for us and I know you already gave some detail on this, how many of the previously mentioned three orders you have got during the quarter. And then it seems like you have a number of other orders left, so I am trying to figure out, given the backlog seems up pretty nicely, how much more could be bullied throughout the rest of the year with orders that are kind of still outstanding?

Tom Swidarski

Yes, I think Michael when I talked about it, first I talked about the area of Latin America and Brazil. That was one of the big ones we have talked previously, in Athens [ph] we said we had one significant order during this quarter and three additional ones in July. So that gave us kind of visibility in Asia, we secured one large order in the recently and feel very good in terms of that along with what we said with India and Southeast Asia activities that we feel pretty good about really both of those regions now. So I think last time we said there is some pretty big opportunities out there, depending on how they go, really impact the year. We feel very good with what we’ve secured and certainly we are not stopping don’t get me wrong. But at this point, a lot of the orders are going to be influencing 2012, not 2011.

Michael Saloio – Sidoti & Company

Okay, and could you just repeat your comments about what the backlog of ATM’s in Brazil? I think you gave a number but I missed it.

Brad Richardson

No, I don’t think I did.

Michael Saloio – Sidoti & Company

Or maybe Latin America.

Brad Richardson

I think I had mentioned backlog in Asia.

Tom Swidarski

Which was up 50%. We didn’t give a number though.

Brad Richardson

Yeah.

Michael Saloio – Sidoti & Company

Okay I thought I heard a number in Brazil.

Tom Swidarski

No.

Michael Saloio – Sidoti & Company

Okay, I guess this second, go ahead.

Brad Richardson

We don’t give specific backlogs numbers. I think what we are trying to do is imply the size of the backlog with significant both there in North America.

Michael Saloio – Sidoti & Company

Okay, secondly, it’s very encouraging to see the turnaround in EMEA could you talk about what regions there, I know you mentioned this in the last call, but what regions are you really focusing on, and kind of where the growth is coming from in EMEA?

Brad Richardson

Sure, I would say that the, this would really be the Western European countries where we have a focus such as the France, the Brazil, Spain, UK. There would also be Middle East is important to us. We are establishing ourselves in Russia, is important and we talked about the steps we are taking there. And then places like Belgium are particularly important to us, so we’ve got a very focused effort relative to those areas.

When you look at the African continent, you would say the most important area within Africa for us is South Africa, I mean the rest isn’t quite the focus we have as we do in South Africa. So again our focus is reemphasize in these areas, resources moving towards these countries what we think we’ve got both some scales, some competency capability and the ability to grow our business there along with taking the, being the disciplined approach of taking cost out across the rest of the region.

Michael Saloio – Sidoti & Company

Okay, that’s all I have.

Brad Richardson

Thank you.

Operator

And at this time there are no other questions in queue. I will turn it back to our presenters for any closing remarks.

Tom Swidarski

Thanks Tim.

John Kristoff

Thank you everyone for joining us this morning and it’s always any follow-up questions should be directed to myself or Chris Bast. Thank you again.

Operator

That does conclude today’s conference call. We appreciate your participation.

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