Diebold Inc. Q2 2010 Earnings Call Transcript

| About: Diebold Nixdorf (DBD)
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Diebold Inc. (NYSE:DBD) Q2 2010 Earnings Conference Call July 29, 2010 10:00 AM ET

Executives

John Kristoff – VP and Chief Communications Officer

Tom Swidarski – President and CEO

Brad Richardson – EVP and CFO

Analysts

Kartik Mehta – Northcoast Research

Reik Read – Robert W. Baird & Company, Inc.

Matt Summerville – KeyBanc Capital Markets

Paul Coster – JP Morgan

Gil Luria – Wedbush Morgan Securities, Inc.

Michael Saloio – Sidoti & Company

Operator

Please standby. We’re about to begin. Good day, everyone and welcome to the Diebold Incorporated Second Quarter Financial Results Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President and Chief Communications Officer, Mr. John Kristoff. Please go ahead, sir.

John Kristoff

Thank you, Christine. 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 second quarter results as of past calls, it’s important to note that we have restructuring impairment and non-routine income in our financials. We believe that excluding these items gives an indication of the company’s baseline operational performance. As a result, many of the remarks this morning will focus on non-GAAP financial information.

For a reconciliation of our GAAP and non-GAAP numbers, please refer to the supplemental material at the end of the presentation. In addition, all results of operations reported today including prior periods exclude discontinued operations.

Finally, a replay of this conference call will be available later today from our website. And as a reminder, some of the comments today may be considered forward-looking statements. Internal and/or external factors could significantly impact actual results, as a precaution, we refer you 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 Tom.

Tom Swidarski

Thanks, John. Good morning, everyone. As you’ve seen this morning, we once again delivered solid core operating results during the quarter despite a market environment that remains challenging. I’m very proud of the continued efforts of our associates around the world.

Diebold is successfully maintaining leading market position to gaining increase traction and others. Our focus on customers is the core competency. It will continue to help us prevail in a challenging and competitive marketplace. I’m particularly encouraged by the sustained improvement in the profitability re-driving in our services business.

Diebold’s key value proposition lies in our ability to deliver unmatched service support and software solution that surround our security and financial self-service offering. A perfect example of the value our customers placed on this element can be found on our recent announcement with U.S. bank.

In May, we announced our partnership with the bank for our Agilis EmPower ATM Software Solution. A multi-vendor software application that will run across the bank’s expanding ATM network. We developed a custom software solution for the bank built on our cross-vendor Agilis EmPower application. As we rollout this solution to U.S. bank, we will achieve a milestone – more than 500,000 ATMs around the world running Agilis software and cross-vendor framework components.

We’re now for another key accomplishment earlier this week, the International Quality and Productivity Center awarded as a Call Center Excellent Award for deploying innovative call center solutions for rapid response, for customer inquiries and service needs. The Call Center Excellent Award honor the individuals and companies’ whose focus on customer service and efficiency that are setting the standards in their industry.

Recognition such as this is not indicative not only of the investment we’re making to raise the bar for our customer service expectation, but also of our ongoing commitment to improve our service capabilities. Our strategy to expand our company’s skill set in software and services is having a real impact on our business.

Our customer’s recognition of the value was adding in this area and our ability to continually improve our operational efficiency is enabling us to achieve sustained profitability improvement in our services business. As a result, we once again increased our service gross margin during the second quarter.

In addition, a more positive global product mix particularly in the United States resulted in notably higher product gross margin during the quarter. This profitability improvement came despite lower than expected revenue in our financial self-service business, which was driven primarily by weak performance in our May operation and a declining Euro.

For the full year, we are reaffirming our outlook. The additional Brazil Elections business, strong July orders in Asia and EMEA and improved outlook in North America give us further confidence in the second half of the year.

Finally, our net debt position improved by nearly 50 million from June 30th, 2009, and I expect we will continue to gain ground on working capital improvements throughout the year.

Now, let’s look at our performance during the quarter and the market environment in the geographic regions. In North America revenue declined 11% during the quarter and the completion of large deposit automation deployment by major national banks national banks crated a very challenging year-over-year comparison. Despite the drop-off in this deposit automation related activity, orders held steady with the prior year period as we experienced growth in the regional bank space.

I mentioned during the first quarter call that we experienced the highest order entry activity we’ve had in five quarters. We’re encourages that this activity continued in the second quarter. However, it’s important to note that we had relatively easy comparisons based on a very weak prior year and we’re now just entering the beginning stages of recovery. We anticipate demand in this segment. We’ll continue to grow, but at a measured pace.

The shift and mix in this segment clearly had a positive impact on our product list margin during the quarter. It wasn’t to the second half of the year we expect product revenue mix in North America to be slightly less favorable as we anticipate increase activity within the large national account segment.

We’re also seeing some increased demand for deposit automation in the regional bank and credit union space. Excluding the effect of the activity by the three U.S. largest U.S.-based banks, shipments of Deposit Automation equipped ATMs more than doubled during the second quarter. As interest in Deposit Automation builds within the regional bank space over the next several years, we believe we have unique solutions that put us in a superior competitive position with those customers.

Our technology offers unparalleled flexibility including bulk note, bulk checks, single note, single checks or a combination thereof at a variety of competitive price point. No other competitor offers this level of flexibility. In addition, we have the largest, most responsive and experienced direct service and sales infrastructure support in the industry, and through our integrated services business model, we offer complete outsourcing solutions. This provides smaller financial institutions an avenue to quickly convert their ATM fleets for deposit automation without a large capital outlay.

As an example during the quarter, we know Bellco, one of the nation’s largest credit union chose Diebold for a comprehensive ATM outsourcing solution. This includes the implementation of 50 advanced Deposit Automation terminals across its fleet of 65 ATMs. Our partnership Bellco provides them with a single point of contact for their ATM delivery channel, along the credit union’s reduced cost, improved efficiencies and more importantly attracts new members.

Finally, in regard to financial reform legislation, it is too early to determine what effect it will have on purchasing decisions based on our recent conversation with many customers. We will, however, continue to closely monitor the situation as it evolves but do not anticipate any impact on our 2010 business.

Let’s now look at our security business. While our outlook in the macro-environment remains mostly unchanged especially as it relates to bank branch construction in North America, we have seen encouraging signs within the enterprise security space. We want a number of solid enterprise security projects during the quarter. Orders for security are up 7% from last year, driven by substantial increases in segment outside of traditional branch security.

Recently, I took the opportunity to meet with our enterprise security team, which is headquartered in White Plains, New York. In March of this year, we consolidated our sales and operational teams in this space to better address all government and retail sales opportunities. This restructuring was designed not only to drive efficiency improvements but also to generate synergies and accelerate our ability to span new orders for our security solutions. I believe we have the right leadership and focus to significantly grow this business.

An important recent win with the contract to provide a comprehensive security system for the new North American headquarters of a major global financial institution based in Europe. I visited the state-of-the-art facility and customer feedback about the capabilities that our security team was universally favorable. Until now, we have not been a provider of ATMs to this institution, but the success of our security installation has built new relationships that we believe can be leverage in a way that benefit other segment of Diebold’s business. This exemplifies the synergies and opportunity that exist in our business.

Looking ahead, we feel that enterprise security and other growth initiatives we have outside of the traditional branch space and select markets in the U.S. and abroad will help us generate growth.

Looking at Asia-Pacific, as we mentioned during our prior call, we anticipate the region returning to its historic seasonality, where revenue is more backend loaded to the second half of the year. From an orders perspective, we drop 11% against a difficult comparison to the second quarter 2009, when orders increased in excess of 50%. These variations in seasonal order entry are not unusual in this region and not indicative of any trend.

In fact, revenue in Asia grew 8% during the quarter in line with our expectations driven primarily by service growth in China and continued increases in both product and service revenue in India.

Given the significant order strength in the region in July, we are confident in our outlook for the second half in Asia. As a result, we expect single digit full year revenue growth in the region coming off very strong performance in 2009.

In EMEA, I’m disappointed in our financial performance during the second quarter. The makeup of our footprint in EMEA with relatively high exposure to the weak Eastern European market continues to present challenges to our growth strategy in the region. We are, however, experiencing success in certain areas of the region and anticipate revenue growth in EMEA to accelerate during the second half of the year, particularly the fourth quarter. We expect areas such as Turkey, Spain, Italy and the Middle East to generate significantly higher second half revenue.

For example, we recently won an order for more than 500 ATMs from the world’s largest global financial institution located in the region. The entire order is expected to be installed and the revenue recognized by the end of the year. This in account where we historically had no presence and this win represents the products we’re making in improving our competitive position in key areas of EMEA. So, while we’re encouraged by the results, we’re seeing in some pockets of the region, much work remains in EMEA for Diebold to be positioned as strongly as it is and other regions of the world.

In Latin America, business remains strong with orders up 29% and revenue up 13% during the quarter. As we disclosed during the quarter, we were awarded for an additional 30,000 voting term over in Brazil, which will revenue in the third quarter. This brings a total number of machines that will be delivered in 2010 to 195,000. We are planning our production schedules and our on track to complete the order as planned.

While the Brazil election business clearly had a positive impact on our order entry during the period, business in Latin America remains brisk. Excluding the Brazil elections contract, orders grew nearly 20% in the region. Our strong market leadership position throughout Latin America particularly Brazil puts us in a prime position to capitalize on growth in the coming years as banks in region begin to deploy deposit automation.

During the quarter, I traveled to Brazil to visit our operations and meet with several key customers. I met with the CEO and senior management team of Bradesco, Brazil’s second largest bank. We have more than 70% of their installed base. They shared with meter experience and they’re extensive deployment of Palm Vein Biometrics throughout their ATM networks, with nearly half of their network of 38,000 ATMs now equipped with biometrics. This represents perhaps the largest use of biometrics for financial self-service anywhere in the world. Diebold played a key role in implementing this technology and I’m pleased to report the project has gone extremely well.

I was also able to meet with top executives, Tec Bank (ph), a shared ATM network that during the last three years has increasingly turned to Diebold for solutions. Today, our products constitute about half of their network

I spent time with other industry leaders as well. These conversations provided strong confirmation that our Brazilian team has developed an enviable competitive position through unmatched development and engineering capabilities as well as the industry’s largest nationwide service infrastructure. We’ll continue to build on our leadership position in Brazil based upon the competencies we’ve developed over the past two decades in design engineering, software and services.

(Inaudible) providing an in-depth update on our financial remediation effort, but I wanted to briefly comment on the voluntary disclosure we made in the earnings release regarding FCPA compliance. While our findings reveal we still have some work to do in strengthening our financial controls, our decision to make this disclosure demonstrates the commitment of this management team to be open transparent and accountable in everything we do. We’ve raised the bar significantly in terms of our financial reporting standards and I’m confident we’re putting the right season in place to complete our financial remediation plan.

In closing, we are where we thought we’d be at this point of the year in terms of overall financial performance and operational result. The additional visibility we have gained gives us increase confidence in reaffirming our outlook for the full year.

Moving forward, we will continue to direct all our energy and focus towards the essential work transforming Diebold into a more competitive enterprise that creates maximum value for all our stakeholders. Simultaneously, we will maintain our focus on implementing and sustaining effective financial controls within our global processes. Our focus is on the future and I’m certain we’ll reach our objectives.

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

Brad Richardson

Thank you very much, Tom and good morning, everyone. There are a number of key topics I’d like to discuss this morning.

First, I’ll come in on our revenue picture for the quarter and full year, and then discuss our strong growth margin performance. I will speak to our working capital and balance sheet and then walk you through the details behind our guidance assumptions for the remainder of 2010. Finally, I’ll discuss our financial control environment including the voluntary disclosure in our release this morning regarding FCPA compliance.

Let’s turn to our financial results. I’d like to refer to slide 12, which focuses on second quarter revenue. Total revenue was $665 million down 4% from the second quarter of 2009 or 7% on a constant currency basis.

For the quarter, product revenue dropped 8% primarily in North America and EMEA. In the North America, the completion of large financial self-service deployment by major national banks created a very challenging comparison. In EMEA, a large scale branch transformation project in Belgium in the prior year period also created a tough comparison.

Service revenue was essentially flat with performance in international markets particularly Asia Pacific offsetting a reduction in installation revenue as a result of lower product sales in North America.

Looking at our financial self-service business on slide 13, second quarter revenue was $469 million down 12% from the second quarter 2009. This decrease was mostly attributable to the drop in product revenue in North America and EMEA.

In the security business on slide 14, second quarter revenue decreased $3 million or 2% from the same period in the previous year. This decrease was due primarily to continued weakness in the U.S. financial market especially in the segment of our business, which relied heavily on new bank branch construction, which continues in the range of approximately 1,600 new branches a year down from a peak of nearly 4,500 in 2007. However as Tom mentioned, we are encouraged by opportunities in the enterprise securities space.

Looking at slide 15, the total gross margin for the second quarter increased two percentage points from the second quarter of 2009. The increase was primary due to improve profitability in the company’s service operations.

Product gross margin for the quarter was up 1.2 percentage points due to more favorable segment mix in the prior period. In service, the gross margin grew 2.5 percentage points during the second quarter primarily due to continued improvement in product reliability and productivity. In addition, we benefited from a vehicle fleet rebate and some other items during the quarter that resulted in a higher than normal service gross margin. For the full year, we expect the service gross margin to be around 26%.

Moving now to non-GAAP operating expense, as highlighted on slide 16 in 2Q 2010 operating expense as a percentage of revenue increased 1.3 percentage points from the comparable period of 2009, largely due to the drop in revenue.

Operating expense in the second quarter increased $3.9 million from the prior period. However, excluding the impact of currency, operating expense was relatively flat. For the full year, we expect operating expense to be in the mid-17% range.

Now turning to slide 17, non-GAAP operating margin in the second quarter 2010 was up 70 basis points compared with the second quarter of 2009. This is the highest quarterly operating margin we have reported since the financial downturn began and is an indicative of our ongoing efforts to reduce cost, increase productivity and pursue profitable revenue growth.

Turning to the EPS reconciliation table on slide 18, GAAP EPS from continuing operations in the second quarter of 2010 was $0.46 per share compared with $0.48 per share in the second quarter of 2009. Excluding restructuring impairment charges and non-routine income, our second quarter non-GAAP EPS was $0.52 per share compared with $0.51% share in the second quarter of 2009.

Our non-GAAP tax rate in the second quarter of 2010 was 28.8%. For 2010, we still expect the full year non-GAAP tax rate to be approximately 28%.

Looking at free cash flow on slide 19, we define free cash flow as net cash from operating activities less capital expenditures. Free cash flow in the second quarter of 2010 was $23.6 million compared with free cash flow of $50.7 million in the second quarter of 2009. Free cash flow in the second quarter includes the effect of the $25 million to the SEC and more than $60 million in temporary working capital associated with the Brazil voting business. Given the normal backend loading nature of our cash flow, we are targeting free cash flow for the full year of roughly $150 million.

Looking at slide 20 and 21 on working capital metrics, our balance sheet remains strong and I am pleased with the year-over-year working capital improvements we made during the quarter. Day sales outstanding improved to 48 days while inventory turns modestly by 1.1 turns. We anticipate continued improvement in our working capital metrics for the remainder of the year, particularly inventory turns as we complete our Brazil election rollout.

Turning next to liquidity and the net debt on slide 22, net debt at June 30th, 2010 was a $194.1 million, a decrease of $46.9 million from June 30th, 2009. Our net debt to capital ratio was 16% at June 30th, 2010 compared to 19% at June 30th,, 2009.

The strength of our balance sheet gives us the flexibility to reinvest as well as return moneys to our shareholders in the form of dividends and share buyback. In regards to repurchasing our shares, I mentioned during our first quarter call, we continue to believe our shares are on excellent value and will take a majored approach to our repurchase program. You’ll see that during the quarter, we repurchased 310,000 shares for a year-to-date total of 647,000 shares repurchased for approximately $20 million. There are 2.3 million shares remaining on our existing board authorization.

Next turning to our full year outlook on slide 23, as Tom mentioned in his remarks, we are reaffirming our outlook. As you can see, we have narrowed our revenue guidance range to 5 to 8% growth. As we have gained additional confidence in the balance of the year, while also receiving the additional Brazil elections system order. The center of our revenue guidance range implies third and fourth quarter revenue in the neighborhood of $800 million per quarter. I’m comfortable that we have the order and backlog to support our significant revenue growth expectations for the second half of the year.

From an EPS perspective, we are on track with our previous expectation. We have the raised the bottom of our range by $0.05, which reflects our increase confidence in the business and the additional Brazil election systems order.

Now, I’d like to address our financial control environment and remediation efforts on slide 24. As you are aware, the company has been working for some time to remediate material weaknesses that resulted from the extensive internal accounting review, which began in 2007. By the time I joined Diebold in November, five of six material weaknesses that had been identified at that point had been either fully remediated or in the process of validation for remediation. A tremendous amount of time and effort went into this process and we’ve made significant progress in improving our financial control environment.

However, we still have a good deal of work in front of us to reach the best in class standards for financial control that we’ve set for ourselves. Earlier this year, we reported a new material weakness related to our income tax control deficiencies that resulted in errors requiring out of period adjustment in our 2009 tax provision. Our tax team has taken significant steps to improve our processes and we anticipate this area will be fully remediated by the end of this year.

The other material weakness we’re still working on to remediate is in the area of accounting policies. To fully remediate this issue, we must strengthen our control procedures related to the application of the revenue recognition policy to multiple element arrangement, which involves contracts with bundled product and service components. This is a highly complex issue that involves a good deal of time consuming, tedious work across multiple geographies. However, we are confident this area will be remediated by the end of this year.

We will continue to communicate our progress to you and disclose any key updates in a timely manner.

If you also note that our press release this morning includes a voluntary disclosure regarding the Foreign Corrupt Practices Act. As many of you are aware, FCPA compliance is an important issue facing all multinational companies. During recent due diligence efforts in connection with a possible acquisition in Russia, we observed some payment and transactions relating to our Russian subsidiary that we fee may raise FCPA issues, particularly the books and records provisioned of this Act.

Our current assessment indicates that the activities in question, which occurred primarily between 2005 to 2008 do not materially impact or alter the company’s financial statement. We also voluntarily contacted the U.S. Federal Agencies with responsibility for looking into FCPA matters, the Department of Justice and the Securities and Exchange Commission. We will provide all of the relevant facts to these agencies and we will cooperate fully with them in any review.

We take seriously the government’s many pronouncements, encouraging companies to self-report any potential issues regarding the FCPA and that’s exactly what we’ve done here. We view this as the continuation of our commitment to transparency and full disclosure after the conclusion of our recent settlement of the longstanding inquiry with the SEC. In the spirit, we’re taking a look at our global FCPA compliance and will continue to enhance and strengthen our FCPA compliance programs.

As we face the challenges presented to us in 2010, we will continue to embrace the highest principles of value and ethics in our relentless effort in sustaining a sound financial control environment.

In conclusion, I am pleased with the progress we’ve made in rebuilding our operating margins. We remain focus on tight control over expenses and continue to leverage our SB 200 cost savings initiative. I am very confident with our ability to deliver revenue growth in the back half of the year given the strength we have seen recently in our order book.

Finally, communicating difficult issues such as those we’re working through in terms of our financial control environment is not easy. However, I am very comparable and proud to say that we’re doing the right thing to not only address our current material weaknesses, but to elevate our financial control environment to best in class level.

And I have the utmost confidence in the people we have in place managing this process. I remain personally committed to maintaining the highest levels of transparency with all of our stakeholders. Based on the progress we’ve made to date and our expectations for the rest of the year, I feel confident that we continue to move in the right direction.

Now, I will turn it back to John.

John Kristoff

Thanks, Brad. Christine will now open the call up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Our question comes from Kartik Mehta from Northcoast Research. Your line is open.

Kartik Mehta – Northcoast Research

Thank you. Good morning, Tom and Brad. I wanted to ask you a question, Tom, you said about a regional bank spent in the U.S. is increasing. I know last year the market was probably down significantly and if you compared 2010 to 2009, what kind of market increase would you anticipate this year out of the regional and community banks?

Tom Swidarski

Hey, Kartik, you’re talking about total revenue comparison or I mean orders or –

Kartik Mehta – Northcoast Research

Yes, I guess I meant revenues. I guess I’m trying to relate it to how the overall market looks.

Tom Swidarski

Yes.

Kartik Mehta – Northcoast Research

And I’m assuming the overall market should be similar to what you would witness.

Tom Swidarski

Yes. So, I think as we take into kind of in its entirety, you have two factors slaying out here. One is security, we’re tapping with security in the regional bank space and the other is self-service. So, on the security side, we’re still challenged in the regional bank space with branch builds from 4,500 level to 1,500, we’re expecting that to continue. So, with such, first part 2009 has some benefit still built in from the security side of the business and really this year, I think the expectations or that’s going to be kind of at the constant level of 1,500 going forward.

Self-service is a stronger story and we’re starting to see – as I mentioned deposit automation activity, the first and the second quarter both significantly improved from last year both in terms of revenue and in terms of orders. But, again, they were relatively weak last year as a result of what happened with the financial reform and the assessment that people received in February. So, it’s encouraging and certainly the order entry is encouraging at the regional space compared to quarter over quarter.

As I said, first quarter was the highest it had been five or six quarters and this quarter continued. But, again, it’s early stages, I think measured kind of improvement here and we expect this deposit automation trend to continue, but I think it’s a long-term moving train and again, I think we’re cautiously optimistic that we’re starting to see some real signs of life here in the regional space.

Kartik Mehta – Northcoast Research

And then just a second question and Tom, your EPS guidance for 2010. Why not raise the high end considering you just received the extra Brazilian election order? Is there something else that’s happening in a couple of the other businesses that just are – as a reason for not increasing the high end?

Tom Swidarski

No. I think, Kartik, from our standpoint, it’s kind of a measured view of where we’re at. We certainly have some signs of optimism by the same token. You still have a lot of headwinds in terms of banks that are still closing in the United States. I mean the financial crisis that has hit; the financial reform that’s out there again creates a little bit of uncertainty when we thought what could be more clarity here.

And those certainly impact us and as we look forward in terms of North America and the other regions, while you see optimism happening to regional bank space here in the U.S. You see that the three major players where you won’t be seeing activity and then you have, for us, EMEA, which is – while we were happy to get some of the order we did in July, EMEA is an area where kind of across the board. We still have a long way to go to get the competitive position we’re in and enjoy in Latin America or Brazil and in America.

So, I think with that all weighed together, we’re feeling like it’s not appropriate at this time.

Kartik Mehta – Northcoast Research

Thanks, Tom, I appreciate it.

Tom Swidarski

You’re welcome.

Operator

And our next question comes from Reik Read with Robert Baird & Company. Your line is open.

Reik Read – Robert W. Baird & Company, Inc.

Hey, good morning. Could you guys just talk a little bit on the service margin side of things? Brad, as part of your comments you talked about 26% for the year. Now, that you are at that level, do you think getting back to the 2002 levels of 28, 29% is doable? And can you talk a little bit about how the expansion of the international markets, particularly China and India, might impact that, and then also the integrated services component of that?

Tom Swidarski

Reik, I’ll start with that and maybe Brad can fill in certain aspects. But certainly for us, when I think of service and services, it’s kind of the key strategic battleground or platform that we differentiate ourselves on, so that the progress we’re seeing were encouraged by it.

If you go back a few years, we’re at the 80 to 90% level and now, coming into the year our expectations were in the 25% and now we think we could really achieve 26. The second quarter has some unusual benefit in it, so I think the numbers above 27, but we don’t expect that to be kind of the real run rate. The real run rate is closer to 26% level. So, the improvement is measured. Its part productivity improvement, part cross-sell, part a stable pricing environment and all those variables will have to remain intact.

So, we see continued improvement there. Mixing in integrated services and again, we’ve got the beginning stages of success there, it helps that, but, I can’t see 28% right now. But I certainly would think as we reset new goals and think about 2011, ‘12 and ‘13, my expectation is we’re going to achieve near 26 this year and we’re going to be pointing towards 27 over the next 18 months after that. But I want to make sure we hit 26 this year that would be a market improvement over the past several years.

And again, as the integrated services ramps up, it gives me expectations that we practically can continue to walk this up and it helps certainly offset the fluctuations we have in product gross margins. So, for us, it’s the quality of earnings, it’s the stability of the recurring revenue and we are going to make sure that the business we take there is accretive. So, there are – our cases when you look at certain contractors, certain environments where we’ve walked away. But I think overall we’re really happy with both the revenue side of the picture on service, in-services as well as the margin side.

Brad Richardson

Tom, I’ll just add one more point.

Tom Swidarski

Yes.

Brad Richardson

Which is part of Reik’s question, which again I think your question Reik was also how the international mix might impact this. And certainly again that’s been another enabler, if you will because of the quality of our international service business, if that continues to expand that also gives us the additional ability to grow our overall service gross margin overtime.

Reik Read – Robert W. Baird & Company, Inc.

Does it have a near-term impact, Brad, one way or the other? Or is that just slow and steady, and it just increases over time?

Brad Richardson

I would absolutely kind of leave you with the impression, which I think Tom did too, of slow and steady over time.

Reik Read – Robert W. Baird & Company, Inc.

Okay. And then could you guys maybe just comment on the international opportunities out there? I mean China has historically not used much of a national service presence. They seem to be more concerned about uptimes. Can you talk about what that may be leading to you guys in terms of growth opportunities?

Tom Swidarski

Yes, certainly. It clearly differs by region of the world, but certainly you picked a big country in terms of China, where our service presents or presents of the OEMs is much lower than most other developed countries. Again, I see that long-term as opportunity. Short-term is – those are not big opportunities during the short-term, but that’s a slow ship that’s going to turn over time, which I think puts it squarely in our sweet spot that we think we’ve got opportunities there.

But in that case, I view that as much more demand creation than it is in other parts of the world. Though China’s with the installed base, it’s growing there. We’ll provide huge opportunity relative to service, but it’s very small right now and small comps that’s why your percentages couldn’t be exciting. But really it’s still very, very small based, but we’re working hard there – Thailand, India, Indonesia, all those growing countries because we do think long-term, they will end up with a model that’s much closer aligned to North America and Western Europe, where they’re looking for the most efficient, most effective way to get there.

Right now, they use brute force of internal manpower to do it, and I see that change, but that’s a long haul change.

Reik Read – Robert W. Baird & Company, Inc.

Great. Thank you, guys.

John Kristoff

Thanks, Reik.

Operator

And our next question comes from Matt Summerville with KeyBanc. Your line is open.

Matt Summerville – KeyBanc Capital Markets

Good morning. A couple of questions. First, Tom, can you maybe comment on the magnitude of order growth you’ve seen in July and what the year-over-year comparison looked like? I guess I’m trying to get a sense for kind of what’s really changed outside North America. It sounded like EMEA and Asia-Pac driving that in the last 30 days.

Tom Swidarski

Yes. I think a couple of things. One is a lot of it had to just do with timing and when they may occur. So, something occurs the first part of July, could’ve been in June and all of a sudden your order picture looks different in a quarter. So, in the EMEA case, there were a couple of small order and a major order that just happened in July. I also attribute that somewhat to the fact that in August, there’s going to be no activity even in the EMEA region or a lot in Europe doesn’t really have their heads down in August.

In Asia’s case, it was expectations. We’ve known the second half of the year really was – Asia was going back to more historic seasonality and we were just happy that we got this confirmation here in July rather than further our in – again, it gives us – both of those give us confidence relative to both the revenue and EPS guidance for the remainder of the year.

But I think EMEA was much more timing in terms of June decisions happening in July and Asia Pacific was much more second half of the year decisions that came early in second half, which bode well for us.

Matt Summerville – KeyBanc Capital Markets

Sticking with Asia, you were flat in the first quarter, up 8 in the second quarter. Still talking about single digit growth this year against low single digit growth in ‘09. How does that kind of reconcile with the strength you’re seeing in the back half of the year there, I guess? Why isn’t the outlook for Asia more robust than single digit?

Tom Swidarski

Yes. I think some of that has to do with certain contracts that occurred last year that certain institutions won’t be ordering this year. So, for us the comps going to continue to get tougher as we go forward, but based on the opportunities we see out there and how we think we’re positioned there, we think, again, the second half is going to bode well and being up single digits is going to be solid performance there for us this year.

Again, because we don’t have the large service reoccurring revenue base there like we do in maybe North America, it becomes much more of a product focus type of revenue gain and it that case, you’re depending on whose letting out what orders, you’ve got much more lumpy kind of scenario. But, I think we’re satisfied with our outlook here at Asia for the remainder of the year and as we get possibly surprise, that would be great, but we’re pretty confident what we can deliver.

Matt Summerville – KeyBanc Capital Markets

And just one more question, I’ll get back in queue. With regards to, Tom, I think you mentioned it a moment ago and Brad mentioned it in his prepared remarks. Kind of an unusual one time – whatever the right term is – benefit you saw in the service business in the quarter. How much was that in dollars would you say?

Brad Richardson

I think – Matt, let me respond to that. I mean roughly we saw about a percentage point benefit in our service margin from base, fleet rebase as well as some other items. So, a percent on, what equate to a little over $3 million.

Matt Summerville – KeyBanc Capital Markets

Thanks, Brad.

Operator

And our next question comes from Paul Coster with JP Morgan.

Paul Coster – JP Morgan

Yes. Thank you for taking my question. Tom, in your prepared remarks you said in the second half of the year your margins will probably come down a little bit owing to a shift towards sales, international accounts. How do we – first of all, have I got that right? And secondly, does that – how does that reconcile with the fact that the national accounts seem to have largely played out?

Tom Swidarski

So, a couple of things there. The product margins certainly in the first half of the year, the second quarter were impacted a lot by the regional bank activity here in the U.S. Part of the issue in terms of product margins, the second half of the year in the U.S., we will have besides the big three, there’s a lot of other large strategic accounts here in the U.S. There’s going to be activity in those that impact kind of our outlook for margins.

And then secondly, the international ones based on the orders that we have taken in July, we’re pretty clear in terms of – that the margins were below what we enjoyed here in the second quarter. So, I think we’ve got pretty good visibility in terms of the impact relative to those product gross margins both in the U.S. and also the international orders that we have coming.

Paul Coster – JP Morgan

Got it. Okay. And then the enterprise security businesses are a bit opaque to many of us. Can you just give us a little bit of a sense of the size of the deals, how long it takes to land a deal, what the duration of the contract is, and any other color that you think will help us kind of get a grasp on this business?

Tom Swidarski

Sure. The way I would – maybe first let me describe enterprise security, so everyone has a similar understanding.

Historically, Diebold did a lot of security business in small retail outlets like bank branches and other things that look like bank branches and we monitor those and we put in, physical and electronic security into those type of environments. We made an acquisition several years ago, where we wanted to take our capabilities to what I would call is much more critical infrastructure type facilities and whether that be high-rise buildings in New York City or court authorities and water treatment facilities, but it’s a much more sophisticated type of security capability that needs to be delivered.

So, as such, when we talk about reorganizing our security group outside the bank space, we basically said for government, retail and this commercial critical infrastructure group. We have a sales organization and we have designed infrastructure piece there, and that’s helping us in that regard. So, many of these are large orders. The one I referred to in terms of the European bank that build a headquarter here in the U.S.; these are $3 to 4, 5-million type of projects.

So, that would include 30 or 40 or potentially 50 floors of security type of capabilities designing it and then putting a monitoring center right in the facility. This one is sophisticated enough that when you put your access control, so you have badge to get into different floor, but also points you to certain elevators. So, right when the software and tying all that together, each of these is unique, but the skill set of project management, of implementation fits into our capability and the acquisition we made relative to this organization three or four years ago, were much better able to integrate those.

So, we have opportunities that win significant contracts from the tune of 5 to 10 million. You compete against a different set of players that we historically have in the security space. It’s taken us a few years to kind of get ourselves grounded there, but much likely won the United States Postal Service contract, I think we have on our horizon the ability to win significant multiyear contracts that are in a $5, 10, 15 million range going forward.

In terms of how long it takes this, because of the size of these contracts, they can be six-month type of RFT processes. They’re very technical in nature, but also then the revenue stream will be spread out over probably 24 months or in some cases, some of these facilities take two or three years to build. So, it bodes well for us in terms of building that confidence, the other thing is we’re taking that then back to the financial sector, where we know all the banks, and now, we look at their operation centers, we look at their high-rise main office facilities. They give us an opportunity to take that back to banks and put ourselves into different (inaudible) from a security standpoint that helps us on the IT side and helps them with logical security as well as physical and electronics that you’ve been doing previously.

So, it’s a good story. It’s just beginning to unfold for us and timing is very good given our outlook relative to the branch construction, “Business and electronic security tied the branches in the U.S.”

Paul Coster – JP Morgan

Thank you that was helpful. I got one last question. Regarding the Brazil electoral systems business is there any chance at all of seeing any follow-on business next year, or do you feel like it kind of comes to conclusion?

Tom Swidarski

Well, on the last call, I was indicating that there was some expectation that we would see some additional business in 2011. the order that they recently placed in 2010, I was a little bit surprise by that, our expectation was that was going to happen next year, and while it may not completely come to a close because they still can order an additional 30 or 40,000 units from the regional RFP, the comparison will be much larger now in terms of what we delivered this year in terms of review as in terms of next year.

While we don’t have any confirmation of that, the fact that they ordered this year takes a lot of what we thought could happen in 2011 off the table. So, we’ll be working with them closely. There’s no guarantee on this, but certainly the gap will be much larger than maybe we anticipated on the last call.

Paul Coster – JP Morgan

Great. Thank you.

Tom Swidarski

Yes.

Operator

And our next question comes from Gil Luria with Wedbush Security. Your line is open.

Gil Luria – Wedbush Morgan Securities, Inc.

Thank you. First, just to wrap up that point, so if this year195,000 units, $130 million, by most estimates about $0.30 a share this year, what you’re saying is that next year, at most it will be a quarter of that size just because of what’s left on the order?

Tom Swidarski

Yes, Gil. I think that’s excellent math, and again, while there’s no guarantee in terms of them ordering the additional units, our thought was originally that – our thought was originally there would be a lot more revenue opportunity. Now, we’re thinking the revenue might be in the neighborhood of $25 to 30 million for next year, so a big difference from Q1 or from our last call.

Gil Luria – Wedbush Morgan Securities, Inc.

Great, thank you. Then in terms of operating expenses, in our presentation is says that year-to-date operating expenses are flat, excluding currency. Does that mean that we’re no longer getting gains from Smart Business, or does that mean that we’re taking all those gains and reinvesting them in the business?

Brad Richardson

Yes. (Inaudible). Gil, I was just going to respond to that. It’s certainly I would just remind you some of the SB 200 does come through the operating expense line, but also majority of it comes through the cost of goods sold lines, so I just kind of remind you on that. But, I think you are right from the standpoint of the reinvestment and we signaled and certainly, I’ve covered on the slide that we also had signaled that part of the savings that we have had from some of the reduction in sports (ph) activity is being reinvested back into our R&D activity.

Tom Swidarski

I think also on the slide, when you look at it, Gil, you’ll see that our expectation for the second half of the year, the percentage changed dramatically. I think for the full year, we’re talking in the – with a 17.5%.

Brad Richardson

Right. What they had is revenue. I mean –

Tom Swidarski

Yes.

Brad Richardson

Certainly, we’ll be in the low 16% OpEx as a percent of revenue in the second half that’s giving us the mid-17.5% for the full year that Tom just mentioned.

Gil Luria – Wedbush Morgan Securities, Inc.

Got it. And then just on the – to ask another question a little differently about the U.S. regional banks and the U.S. market, could you give us the cut of year-to-year expectations for the year for just for the financial self-service business, just in the U.S.? Are the U.S. regional – is the new pickup in U.S. regional bank activity enough to offset the business that you had last year from the larger banks?

Tom Swidarski

Okay. So, your question is with the large bank slowing down are the regionals able to kind of fill that bucket. Is that in essence, Gil (ph)?

Gil Luria – Wedbush Morgan Securities, Inc.

Yes, just a year-over-year revenue comparison financial self-services in the U.S., 2010 versus 2009.

Tom Swidarski

Okay. It’s a regional space?

Gil Luria – Wedbush Morgan Securities, Inc.

Total U.S.

Brad Richardson

Total U.S.

Tom Swidarski

So, in essence, from the total we will probably down slightly from a revenue standpoint year-over-year, which I think when you mix it all together suggest that the regional bank performance is going to be pretty strong and we’ve experienced that the first of the year both in terms of revenue and in terms of orders, and we expect that to continue into the second half but not completely offset the large three in terms of revenue. But certainly, the flip side of that story is that’s a good story on the regional side plus you see the benefit from the margin expansion.

Gil Luria – Wedbush Morgan Securities, Inc.

Got it. Thank you.

Operator

And our next question comes from Michael Saloio with Sidoti & Company. Your line is open.

Michael Saloio – Sidoti & Company

Hi, thanks for taking my question. Tom, I was wondering if you could quantify a little bit about the type of growth you possibly saw in integrated services in the quarter? I think last quarter you mentioned that you had added about $20 million in revenue to the $100 million you had in remaining contract value, if I’m understanding that correctly. Could you give us an update there?

Tom Swidarski

Yes. I would say that again I’m pretty pleased with the response that we saw, similar growth in this quarter. Well, and that the level of activity that’s occurring relative to integrated services is complimentary to what’s happening in deposit automation. So, I would expect that trend to continue on a regular basis and possibly begin to ramp up as more of the smaller institutions getting involved in integrated services or look at PCI compliance and security issues that kind of leads them right to an integrated source solutions offering.

So, for this quarter, it’s very much like it was in Q1.

Michael Saloio – Sidoti & Company

Okay. And secondly, still seeing good order growth in Latin America, even excluding Brazilian elections. Could you give us a sense of how margins are holding up? In particular, in Brazil with some of the increased competition you’re seeing there now?

Tom Swidarski

Yes. I think the – our margins are the same in Brazil – they’ve had been historically. As I mentioned, (inaudible) either pick most customers but because of the – kind of our large relationship there and the unique capabilities of what banks are looking for – I mentioned the Palm Vein, simply because no one else in the world was able to kind of accommodate that. So, we work with them, develop that and then they’ll deploy that across their whole network.

So, it’s that uniqueness that allows us to maintain, I think, a pretty solid competitive position relative to the Brazilian competitors and others that are in that market as well.

Michael Saloio – Sidoti & Company

Okay. Thanks.

Operator

And our next question comes from Reik Read with Robert W. Baird & Company. Your line is open.

Reik Read – Robert W. Baird & Company, Inc.

Just a quick point of clarification on Asia. When you were talking about single digit growth, was that for the year or for the back half of the year?

Tom Swidarski

No, that’s for the full year.

Reik Read – Robert W. Baird & Company, Inc.

Okay. And then if I could just go back and follow-up on the integrated services. Can you tell us what the remaining total contract value is for all of the integrated services at this point?

Tom Swidarski

I’m not sure I have that right in front – maybe we’ll take that one offline so we get that correct. And the way we do that in terms of total contract value and mostly either five-year contracts, in essence, you’ll see about 40% of the revenue year one. So, I’d have to go back and look at the previous years to make sure I’m giving you the information correctly.

But, in essence, if every contract is spread over five years and you get 40% in year one, then you’re looking at the remainder from a services standpoint over those subsequent years or so.

To cut it to your point, as we move in the business it gives us more and more recurring revenue and outlying years, and at some point it starts becoming meaningful number. We’re still at the early stage of there, but I don’t think I have an exact number to kind of (inaudible) –

Reik Read – Robert W. Baird & Company, Inc.

I can follow-up, Tom.

Tom Swidarski

Okay.

Reik Read – Robert W. Baird & Company, Inc.

And just – I guess a follow-up off of that. I mean you’ve got this nice set of offerings that you’ve created, and you’ve pretty much talked about that being focus on a lot of the smaller banks. Are you finding any larger banks are interested in a portion or all of those offerings?

Tom Swidarski

Yes. I’m – I guess more than pleasantly surprise in that regard in that the – in essence, we’ve built and through Brazil and through our efforts development in the U.S. in deploying this that basically the infrastructure that we’re building, the ability to manage, operate, comply, security, all the aspects of managing a complex network and being able to take cost out, we’ve had more than a few of the very largest bank in the world taking a look at this. And I wouldn’t be surprise in the next six to nine months that several want to actually begin thinking about deploying some of the aspects of this.

So, again, it’s surprising in that regard that that wasn’t the intent, but we’re really happy with the robustness of the solution when they compare to everything else in the marketplace. By the same token, that’s infrastructure is what we’re using for all of the folks that we would manage their network for them. So, it would cause us to rethink whether we can manage every network because every (ph) bank doesn’t want that, but our goal was to manage it from a services standpoint.

We may find ourselves creating some product out of this that we sell and let people utilize themselves. So, we’re working our way through that but it’s a result of interest expressed.

Reik Read – Robert W. Baird & Company, Inc.

So that’s not necessarily a real near-term opportunity, but the trend is that in 2011 you probably see more of that than you otherwise might?

Tom Swidarski

Yes. I think that – that I think that’s right.

Reik Read – Robert W. Baird & Company, Inc.

Okay. Great, thank you.

Operator

And our last question comes from Matt Summerville from KeyBanc. Your line is open.

Matt Summerville – KeyBanc Capital Markets

Just a follow-up question on your – just your ATM strategy in Europe. You’re obviously a distant third player. You have a strong presence in France, Italy, Belgium, maybe some other areas. You recently kind of withdrew a more direct presence from Germany. I’m not sure kind of how this FCPA thing changes your strategy with regards to how you build out Russia.

But, I guess as you think about Europe longer term, do you re-engage some of the tier one markets like Germany and the U.K. where you don’t have a big presence right now? And I guess kind of going forward, how does this change your strategy with Russia, if at all?

Tom Swidarski

Okay. So, I think, Matt, we absolutely reengage in certain select markets where we think we have offerings that can differentiate us. Some of those offerings are more services oriented than they are kind of a product. So, you mentioned some of the countries, some additional ones like Turkey and parts of Africa and the Middle East are critical ones. So, we’ve got pretty solid presence in certain areas.

Spain, we have a presence, we don’t have enough of a presence. So, Spain is an area, I think that’s strategically important because those banks influence what’s happening in Latin America and those banks are the ones we engage with through Latin America, but we don’t do a lot of business in Spain. We expect to change that in the coming years.

U.K. is certainly a target country for us to gain traction in and move in there. Again, I don’t view moving in their in terms of trying to give them a cheaper ATM because they’ve got ATM suppliers. I look at unique things we could do either on the software side or some combination of managing a network to solve a problem that no one else has been able to solve there. So, we’re going to approach each of those slightly differently.

But, we have – we’re going to be up in revenue in Europe this year, and we’ll do $450 million, so we do have a solid presence it’s just certain markets we don’t have the infrastructure there yet, but we’ll be building that overtime. So, yes, we are investing in EMEA.

As far as Russia and Eastern Europe, we’ll continue to work our way through the issues there. But, first and foremost, we’ve got to address kind of the issue on the table and make sure that we’ve got the controls in place there. In short-term, that does impact us. I mean there’s no question about it. I mean we’re retrenching, we’re looking at the leadership team there, we’re looking to get how that is organize and whether structurally we need to do something different.

So, I expect that impacts us in Eastern European here in the short-term, but it’s the right thing to do for the long-term health of both the company and sending the right signal to how we operate around the world that if someone does something that’s inappropriate or accidentally, it doesn’t matter. I mean we’re going to upfront address this and regardless of the business implications, deal with it. So, I’m confident we can deliver our results despite what we’re going to be faced with in Russia and the other uncertainties we have kind of around the world.

Matt Summerville – KeyBanc Capital Markets

Appreciate the perspective. Thanks, Tom.

Tom Swidarski

Yes.

Operator

And now, I turn the call back to Mr. John Kristoff for any closing remarks.

John Kristoff

Thanks, Christine. Thank you for joining us this morning.

But before we go, I wanted to mention our upcoming Diebold Investment Community Conference beginning the evening of September 14th, which will take place at our headquarters here in North Canton, Ohio. We will begin with a reception with our entire management team at our Customer Global Solution Center. Then on September 15th, we’ll hold the main presentation portion of the event and we’ll also conduct some breakout sessions on topics such as North America Market Review with our North American Management team, Deposit Automation with some of our top engineers with tours at our labs here and also, Integrated Services and more.

So, we will be sending out some information on that shortly, but I wanted you to mark the dates on your calendar. Again, that’s September 14th and 15th.

And as always, if you have any follow-up questions, please don’t hesitate to reach out to myself or Chris Bosch (ph) following the call. Thank you very much.

Operator

That concludes our call for today. Thank you for your participation.

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