Diebold's CEO Discusses Second Quarter Results - Earnings Conference Call

| About: Diebold Inc. (DBD)

Diebold (NYSE:DBD)

Q2 2012 Earnings Conference Call

July 30, 2012, 10:00 am ET


John Kristoff – VP, Chief Communications Officer

Tom Swidarski – President, CEO

Brad Richardson – EVP, CFO


Kartick Mehta – Northcoast Research

Matt Summerville – Keybanc

Gil Luria – Wedbush Securities

Roman Leal – Goldman Sachs

Michael Kim – Imperial Capital

Paul Coster – JPMorgan


Good day, everyone, 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 Vice President and Chief Communications Officer, Mr. John Kristoff. Please go ahead, sir.

John Kristoff

Thank you, (Deanna). 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 an 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 in past calls, it's important to note that we have restructuring, non-routine expenses, and impairment charges in our financials. We believe that excluding these items gives an indication of the company's baseline operational performance.

As a result, many of the remarks this morning will focus on non-GAAP information. For a reconciliation for our GAAP to non-GAAP numbers, please refer to the supplemental material at the end of the presentation.

In addition, all results of operations are reported today, including prior period, 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.

Thomas Swidarski

Thanks, John. Good morning, everyone. Thanks for joining our call today. We generated solid top-line growth during the quarter and we improved our net debt position by nearly $50 million. Also we achieved profitability in AMEA during the quarter and are on track to achieve our goal to be profitable for the full year in that region.

We saw more than a 30% revenue growth in Latin America and Brazil a region where we are building upon our leadership position. I'm also pleased with our overall top-line performance as we experienced strong financial self-service growth in deposit automation with national account customers in the United States.

However, as expected, we saw reduction in the regional account activity associated with ADA compliance. This shift in activity resulted in a less profitable mix of business in our North American operation. Combined with a much higher tax rate in the quarter, this resulted in a sequential drop in earnings from the first quarter.

Given a recent significantly negative shift in currency, recall the delay of anticipated additional revenue from Brazil elections system into 2013, we are tightening our guidance for 2012. Aside from these two items, our outlooks remains unchanged and we are confident in the underlying factors that are driving growth in the business.

Now let's look at the business from a geographic standpoint starting with North America. Revenue in North America increased 18% from the second quarter, 2011 driven by continued strong performance in financial self-service partially offset by the decline in security.

Importantly, total order entry in North America Group in the low single-digit range had very good performance in second quarter 2011 when we saw double-digit growth in borders further illustrating the robustness of the market in our leadership position. This growth was driven by significant increase in the national accounts segment associated with the deposit automation adoption.

When looking at deposit automation shipments through national account excluding D of A, Chase, and Wells, we saw an increase of more than 150% with multiple customers accounting for the growth. This represents a good, sustainable trend. Also, deposit automation shipments to the regional bank segment increased nearly 50%.

We also grew our service revenue in North America. In addition to the increased installation volume, we saw nearly 30% increase in our Integrated Services revenue and a 50% increase in Managed Services reflective of our continued focus on growing our software-led services business.

While service gross margin in the quarter was down due to certain increased cost, we expect full year gross margins to be similar to 2011. Brad will provide more detail regarding our service margin in his commentary.

From my perspective, the most important element here is growth, particularly in the Managed and Integrated Services. Our expectation is that we will continue to grow our service and business overall in North America in 2012 strengthening the foundation upon which our market leadership in the region is built.

Looking at our security business, revenue decreased slightly consistent with our prior expectations. Orders decreased in the low single-digit range against a difficult comparison to last year when we had particularly large orders associated with United Nations building in New York.

I'm very encouraged by the progress we're making in the financial electronic security space where we've been focused on building a dedicated sales force service infrastructure and delivery platform for Integrated Services.

In fact, during the second quarter, we grew electronic security orders more than 20% in the banking segment.

Two great examples of our ability to deliver services in the banking sector occurred during the quarter with separate Integrated Services agreements with Regions Bank and BB&T.

We're performing security monitoring for both financial institutions and enhancing security for their customers, employees, and assets with the major benefit of financial institutions continually strive to improve for activity and focus resources under key operations.

Along these lines, our total contract value for IS security to financials increased from about $4 million in the quarter to about $10 million in the second quarter. While these aren't large numbers, this growth reflects the value that financial institutions place on security services and this plays very well to our strengths.

The value of the Diebold brand in security remains powerful and there are extensive opportunities in the commercial industry to build upon the trust we developed with our customers from self-service through security.

The recent appointment of Tony Byerly as EVP of electronic security will be invaluable in helping us execute our strategy to grow the electronic security business.

Having most recently served as President and COO of Stanley Convergent Security Solutions and also having spent his career with ADT, Honeywell, and other leading security companies, Tony brings with him more than 25 years of experience, deep relationships, and credibility within the security industry.

During the past several years, we've developed a top tier infrastructure to manage and monitor complex security systems.

In addition to the organic growth potential Integrated Services represents, we'll also pursue extensive opportunities for smaller (bolt-on) acquisitions as means to position security for long term growth moving forward.

I'm pleased with the progress we're making in transforming our security business, leveraging our capabilities in Integrated Services, reengineering our sales strategy, and recruiting an outstanding new leader, and I'm confident in our ability to generate growth in security in the second half of 2012 and deliver on our security revenue guidance for the full year.

In AMEA, revenue decreased 19% largely the result of a difficult comparison the second quarter 2011, when we reported exceptionally strong growth of 36%. Total orders in the region were down in the high single-digits with growth in Turkey and South Africa more than offset by weakness in Western European markets.

In addition, we have currency headwind as the dollar strengthened significantly against the euro during the quarter. However, the real story in AMEA is the restructuring efforts and hard work have established sound footing in the region continue to pay off.

AMEA swung to a profit during the quarter in the midst of a very difficult macro economic environment. We saw continuing momentum in the deposit automation and recycling driven by Opteva Flex Series of ATMs which we've successfully introduced in Italy, the Middle East, Turkey, and select countries in Eastern Europe during the quarter.

In addition, South Africa remains a robust market for us where we recently secured deposit automation and cash dispenser orders in excess of $10 million. The UK remains an active market and to some extent has been screened off from the larger European economic crisis. While we have virtually no market share in the UK today, we see opportunities in this market and are investing.

The UK financial self-service terminal fleet is aging. Their average age is 10 years, well past the typical retirement schedule of seven to eight years. During a recent visit to London, I had the opportunity to meet with leaders from several tier-one banks. They recognize that deployment of new technology is overdue and major new investments will be forthcoming in the next few years.

Each also recognized that Diebold has the unique capabilities that can add value and a strong third player in the European market. I also attended the launch of our Opteva 820 at the European ATM Conference and Expo.

My conversations with customers made it clear that the 820 smaller designed combined with enhanced functionality is spot on for the UK market.

Going forward, there's a clear opportunity for us to provide a credible alternative self-service offering in this market. As such, during the quarter, we brought on John Ennis to lead our sales and service activities and execute the company's growth strategies in the UK and Ireland.

Prior to joining Diebold, John gained 20 years of experience in financial self-service holding several senior management positions in the banking and supplier sectors, ost recently leading Wincor's banking division in the UK.

John's banking and technical expertise combined with his experience in the UK will be highly valuable in helping us establish a sound position in this important market.

So as we look at AMEA -- as we look to the AMEA region as a whole, important actions were taken to ensure that we've aligned the organization to maximize our ability to compete effectively while taking hold and we feel we're in stronger position to achieve sustainable profitability in the region moving forward.

Looking at Latin America and Brazil, revenue in the region increased substantially by more than 30%. This comes against a relatively easy comparison for the second quarter 2011 in which business was heavily back-end loaded during the year.

We had continued strong performance in the region with very good activity in financial self-service including our bid 17,000 teller terminals and an order for more than 200 ATMs in Brazil.

Orders in the region during the quarter declined in the mid single-digit range due primarily to a couple of very large orders in Brazil that were expected to come during the second quarter but won't close until the third. Therefore, we expect order growth to be very good in third quarter as we continue to lead the market in Brazil.

I had the opportunity to serve as a keynote speaker at the (C-OP) conference in Sao Paulo last month, the largest such conference for our industry in the Americas.

During my trip, I met with various banks including (inaudible), and (inaudible). Our conversations confirmed for me that our innovative solutions and service infrastructure, which have been long-established in the market, continue to give us a competitive advantage in Brazil. So we're well-positioned to win a number of other opportunities there as we progress through the year.

Looking at the elections business, Brazil election officials recently affirmed their intent to purchase 90,000 voting terminals from us in 2012. To date, the government has ordered 35,000 units, which we'll revenue in 2012.

However, they also informed us that they will not be ordering any additional terminals until after their elections in October. This means any revenue from these additional terminals would be recognized in 2013.

We had previously anticipated delivering 60,000 units in 2012. We have adjusted our full-year revenue and earnings guidance accordingly.

Looking to the rest of Latin America, the market remains very strong. During the quarter, Venezuela, Peru, and Mexico each performed very well in winning new business in the financial self-service space.

In summary, we continue to maintain a market-leading position throughout Latin America and Brazil and are well-positioned to capture a significant amount of growth expected to occur there in 2012 and beyond.

Looking at the Asian Pacific region, revenue was flat from the second quarter 2011. So orders in the region declined compared with a very strong quarter last year. Demand continues to be robust in China with particularly active order levels in the regional bank setting.

In India, revenue declined due to unfavorable currency exchange which caused us to be down on a dollar basis there. During the quarter, major changes began to shift the landscape in the ATM industry in India in a positive direction.

The Indian government began an initiative in the country for the state-run banks to join together to nearly double the number of ATMs over the next two years.

To (inaudible) a bidding process for the number of ATMs needed in this initiative, the government divided the country into 16 zones. There is vendors, distributors, and (ISOs) recently submitted bids in a reverse action to deploy 3000 to 4000 ATMs in each zone.

Under this model, the ATM deployer owns and operates the ATM and receives a per-transaction fee from the bank. This requires a good deal of upfront capital and carries with it significant risk, especially in some regions where little is known about transaction history and trends.

Given these risks and the significant upfront capital required with unknown returns, we opted not to bid on any of the zones as a primary deployer. However, only two of the 16 zones were awarded to a traditional ATM manufacturer.

This gives me confidence in our ability to win ATM and related services business from a number of deployers who submitted winning government bids. We feel this is the right approach for us given our scale and solid track record of providing integrated services and related solutions in India.

In addition to the state-run banks deploying ATMs, the private banks are also being forced to increase deployment in order to remain competitive with the state-run banks. This initiative will also create a major opportunity for us. As a result of all this recent activity, we anticipate demand in India will be actively back-end loaded this year.

In Southeast Asia, we are gaining momentum in deposit automation with our Flex Performance Series of ATMs. We also delivered excellent cash recycling success during the quarter at TMV in Thailand and Mandiri in Indonesia and Suncorp in Australia.

So then looking at the Asian Pacific for the balance of the year given the currency headwinds we face in India, we anticipate flat to modest growth.

Looking at expectations for the full year, our outlook is unchanged. However, the push-out of the elections revenue we expect from Brazil and the negative shift in currency affect our guidance for both revenue and earnings for the full year.

We now expect to deliver EPS of $2.50 to $2.60 per share in 2012. We expect fourth quarter earnings per share to be substantially higher than the third quarter earnings as the entire full-year reduction in revenue and earnings expectations from Brazil elections systems and lottery occurs in the third quarter.

We continue to be optimistic considering the activity we're seeing in our key markets and in the strong position we hold in those markets. Our top-line performance during the quarter speaks positively toward the underlying health of our markets and the breadth of our capabilities.

While we have much work ahead in the coming months to meet our expectations, we're confident in our ability to effectively manage the business and deliver results to shareholders.

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

Brad Richardson

Thanks, Tom, and good morning, everyone. Before I get into our quarterly financial results and 2012 outlook, I'd like to touch on a few key topics from the quarter. First, we delivered 12% revenue growth despite a 6% negative currency impact, which was primarily driven by the Brazilian real and, to a lesser extent, the Indian rupee and the euro.

The solid second quarter revenue results were once again impacted by strong performance in our North American financial self-service business, especially as it relates to deposit automation.

We continue our strategy to transform it into a software-led services company as evidenced by the nearly 30% revenue growth we experienced during the quarter in our North American Integrated Services business.

Also contributing to improved overall performance is the continued success of our restructuring efforts in AMEA. As we communicated during last quarter's call, we eliminated $15 million from our cost structure in the region last year.

During the second quarter, we again saw improved gross margins and, more importantly, we achieved modest profitability. And as Tom said earlier, we are on track to achieve profit in AMEA for the full year despite thick economic headwinds in this region.

Finally, moving forward, a strong balance sheet and anticipated free cash flow supports our growth in key areas such as software, services, and electronic security.

Now to review our financial results, turning to Slide 14, total revenue was $743 million, up 12% from the second quarter 2011 including a 6% negative currency impact. For the quarter, service revenue increased 2% and product revenue increased nearly 27%, again driven by financial self-service in North America.

Looking at our financial self-service business on Slide 15, second quarter revenue was $590 million, an increase of 16%. This includes double-digit growth in North America, Latin America, and Brazil. As Tom mentioned, service revenue grew 4% primarily due to growth in North America.

In the security business on Slide 16, second quarter revenue was $144 million, a decline of 3%. As we've noted on previous calls, the strategy for the security business is to focus on building our electronic security sales in the financial industry and we saw a good, sequential increase from the first quarter, which builds our confidence in the long-term growth prospects for our electronic security business.

As such, we are making the necessary investments in our leadership team and infrastructure to build our presence within this space.

Additionally, we continue to gain traction in the Security Integrated Services business and as opportunities in the electronic security industry grow, especially within the regional bank space, we remain confident that we will achieve our full year security revenue guidance of 1% to 4% growth.

Turning now to Slide 17, total gross margin for the second quarter decreased one percentage point from 2011. Service gross margin for the quarter was down 70 basis points due to a number of items.

Let me explain. First, we are making significant investments in our Integrated Services infrastructure including support of the large outsourcing contract with Toronto Dominion that we will begin executing at the end of this year.

And as we expect our Integrated Services to expand in both financial self-service and security, it is necessary to invest in the infrastructure to support that growth.

Secondly, the number of previous generation ATMs replaced with Opteva units in North America during the first quarter was significant. This resulted in high scrap expense associated with inventory no longer needed to service the older units, which negatively impacted our margin.

Finally, we invested in new technology to improve the efficiency of our North American service fleet during the quarter. Even considering these factors, we still expect to maintain our full-year service margins at comparable levels to 2011 given our expansion in software and services and cost improvements in other areas of business.

As anticipated, we experienced pressure on product gross margins during the quarter, declining 1.3 percentage points due to an unfavorable geographic and customer mix.

Moving on to non-GAAP operating expense as highlighted on Slide 18, in the second quarter, operating expense as a percent of revenue was down 1.9 percentage points primarily due to operating leverage on higher revenue.

In addition to controlling costs through Smart Business 300, we are investing in our IT and global business services to reduce our long-term cost structure and we are investing in certain strategic initiatives to improve our sales and security infrastructure.

We've also stepped up our investments in R&D to support future offerings in financial self-service and security. So even with these increased investments, we expect our full-year operating expense to be around 18.5% of revenue, a substantial reduction from 2011.

Now to Slide 19, non-GAAP operating margin in the second quarter increased to 6.4% from 5.6% in 2011. On a dollar basis, operating profit rose nearly 30%.

Similar to the first quarter, this increase was driven by strong performance in North America as well as improved profitability in AMEA. As such, we remain confident that our full-year operating margin will be in the low to mid 7% range.

Turning to the EPS reconciliation table on Slide 20, non-GAAP EPS moved from $0.44 per share in the second quarter of 2011, to $0.49 per share in the current quarter. Our non-GAAP tax rate moved up considerably from 24.9% in 2011 to 34.4% in 2012.

The 9.5 percentage point increase is attributable to more income in jurisdictions with higher tax rate. Additionally, a non-recurring discreet item related to state tax benefits reduce the effective tax rate for the second quarter of 2011. Our full-year EPS guidance assumed a non-GAAP tax rate of around 27%.

Slide 21 provides some insight on sequential decline in non-GAAP EPS. As shown, EPS declined by $0.25 from the first quarter of this year. The majority of the decline came in North America resulting in a much stronger mix of national account revenue as well as increased service costs recovered earlier.

These items resulted in a three percentage point decline in total gross margin and an $0.18 reduction in EPS contribution in North America alone.

From a global standpoint, the net result was a $0.16 reduction in EPS contribution. The higher tax rate also contributed to lower earnings per share in the second quarter.

Turning to Slide 22, free cash use improved $6.3 million in the second quarter while year-to-date free cash used improved by $69 million. As such, our free cash flow will be more balanced this year but we still anticipate a strong fourth quarter.

Our significant improvement in free cash use year-to-date coupled with continued high profile enterprise-wide initiatives put those in a position to potentially exceed $170 million in free cash flow for the year.

Looking at Slide 23 and 24, day sales outstanding again improved by four days from the prior year to 48. Inventory turns improved slightly during the quarter versus the prior year. While we are at the highest second quarter inventory turn level in several years, we have room to continue to improve inventory turns as we move forward.

Moving next to the liquidity and net debt slide on Slide 25, we finished the quarter in a net debt position of $101 million, a reduction of nearly $50 million from the net debt position at June 30, 2011. As our net debt improves, we retain a solid financial position that gives us the flexibility to reinvest in our business.

In addition to our dividends, our primary use of cash include investments in the business to areas such as research and development, smaller (bolt-on) acquisitions, as well as an opportunistic approach to share buy-back.

During the quarter, we did not repurchase new shares. However, we have roughly 2.4 million shares remaining on our repurchase authorization which will enable us to repurchase shares opportunistically depending on market conditions.

In our full-year outlook for 2012 as shown on Slide 26, we expect revenue to increase 6% to 8%, down from the previous guidance of 7% to 10% due to currency headwinds and the push-out of additional Brazil voting revenue in 2013.

We are also tightening full-year guidance for financial self-service revenues to 10% to 12% due to currency. Security revenue guidance remained unchanged and Brazil elections and lottery revenue is now expected to be in the range of $45 million to $55 million.

We are tightening our full-year 2012 non-GAAP EPS guidance to be in the range of $2.50 to $2.60 per share from the prior guidance of $2.50 to $2.70 per share, again due to currency headwinds and the push-out of additional Brazil voting revenue to 2013.

So at a constant tax rate of 27%, our revised earnings per share guidance represents a 12% to 16% growth off of a 6% to 8% growth in revenue.

Regarding the FCPA investigation as shown on Slide 17, earlier this year we completed our global internal review. We are continuing to cooperate with the Department of Justice and the SEC in their ongoing inquiry.

We have recently begun initial discussions with the government toward a resolution to this matter. However, we cannot predict the timing or nature of any potential settlement at this point. Moving forward, as has been our practice, we will continue to communicate any material updates on an ongoing basis.

In closing, I'm encouraged by our second quarter revenue growth despite significant currency headwinds seen in our core markets. While our gross margins during the quarter were below historical norms due to mix effect and service-related items I discussed earlier, our margin expectations for the full year remain essentially intact.

In addition, we're maintaining our discipline around operating cost containment. Finally, as Tom stressed in his comments, aside from the move in currency and the delay in the additional Brazil voting business, our outlook for the year remains the same.

Our overall performance continues to successfully align us with the strategies and operating targets set within our financial framework. Our revised revenue guidance for 2012 still puts us above our long-term goal of 4% to 6% and we are making strong progress towards achieving our target of 15% sustained return on capital employed.

For the last 12 months, our return on capital employed stands at 14.9%. The strength in our core markets provides the catalyst for our growth expectations moving forward.

In addition, our restructuring efforts in AMEA continue to bring improvements from an operational standpoint and lastly, our solid balance sheet to improve free cash flow performance provides us with the leverage we need to deliver on our commitments as we move into the second half of the year.

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

John Kristoff

Thank you, Brad. (Deanna) will prepare to take our first call -- I'm sorry, first question at this point.

Question-and-Answer Session


Thank you. (Operator Instructions) You first question comes from the lien of Kartick Mehta - Northcoast Research.

Kartick Mehta - Northcoast Research

I'm wondering if you look at today the fundamentals of the ATM market versus like the beginning of the year, kind of worldwide, what markets do you think are in line with what you expected, kind of better than what you expected, and maybe worse than what you expected?

Thomas Swidarski

Let me go by region. I'll start with North America, and I'd say North America is in line with what we expected. We knew coming out of the gate that the first quarter – we didn't know maybe quite the sheer size the first quarter was going to be on the Regions side but we knew it was going to be very strong.

So we saw a lot of the – a little bit of the second quarter being pulled in as a result of the ADA, the deadline. But I'd say really the – both this year and kind of long-term sustainability and the underlying factors of North America remain constant and we're pretty bullish about that.

When I look at AMEA, I would say AMEA overall -- you would say is probably a little worse as the year as gone on relative to some of the Western European countries and so in our case, while revenue, for instance, in the quarter was down and you'd say well, that might be a negative impact for us.

Actually we swung the profitability because it was focused on specific countries there. So overall, I would say for us where we participate, we would say that that's a pretty chalky market and it's pretty volatile but I would say that's probably down a little from what we expected at the beginning of the year.

When I look at Asia Pacific, I would say Asia Pacific is pretty close, maybe with the biggest movement in terms of being more positive in the thought in terms of India and what that could mean really for the outlying years in terms of the actions of the government there because not so much with the state-run banks but really that puts the private banks in the position they're having to play catch-up and so you have opportunities in both of those segments as that unfolds.

So Asia Pacific probably is maybe going to be a little better than we thought at the beginning of the year.

I think the remainder would be Latin America and Brazil and for us, I would say in the self-service piece, certainly if I strip out Brazil voting, the voting piece was different than we expected, I explained, but on self-service side I'd have to say very strong and maybe even a little better than we thought at the beginning of the year.

Kartick Mehta - Northcoast Research

You talked a little bit about India and how the market is changing there. From a growth perspective, what would you expect the growth rate for that country to be from an ATM side over the next couple years?

Thomas Swidarski

Yes, Kartick, I think from our standpoint, the big pieces there have to do really with the managed services side of things. So when you start taking a look, if you're going to look at just unit count you'd say pretty strong growth but the pricing on that is pretty low and how you participate there is a little different.

So for us, I would say it should be double-digit growth environment for us in India with a lot of emphasis on service and services and that really plays into kind of what we think our strength and what we built there within the India market.

Certainly, as you've seen, the dynamics there are changing very quickly. We'll know a whole lot more in the next three to four months how things shake out but we feel pretty good about what's happening there from a macro level standpoint.

Kartick Mehta - Northcoast Research

Just one final question, Tom; in Brazil, there were talks in the marketplace that maybe Bank of (inaudible) was going to put out an RFP and I'm wondering, to the extent that you could talk about, has that RFP been placed and have they determined who's going to supply the ATMs?

Thomas Swidarski

Yes, Kartick, I think we can from the standpoint that they've been pretty public in terms of looking to have a second supplier there. As many may know that Bank of (inaudible), one of the best banks in the world and certainly from a stature standpoint but also in terms of a performance standpoint within Brazil and Latin America.

And they've been captive really to Cal Tech, which is their – was a wholly owned subsidiary there from a technology standpoint, so they are the sole provider in terms of ATMs.

They changed really approaches here this year and fortunately for us, we did win an order from the bank. We've been in the process of working with them and when I visited Brazil on my most recent trip to have a chance to have several meetings both at the bank and at the technology show we were at and had some long conversations there, so I feel very good about our capability, especially compared with what they are accustomed to.

I think for us, it'll be a long relationship unfolding over many years and the first pieces of the hurdle, you have to go through certification, you have to go through all the internal hurdles you might imagine with a bank with 30,000, 40,000 ATMs and the local sophistication they have.

But to date they were very positive to me in terms of kind of where we stood, the pace with which we were pushing them, not them pushing us, and our ability to really not only get in there but on really the hardware side but on the services side, as well, which is really key.

So we have some pilots going on certainly from a technology standpoint but more interesting to me was a lot of pilots going on with services side, which I think is really encouraging because that gives you really the sustainability that you have versus just selling a piece of hardware. So feel really good about that and I think 2013 for us will shape up very nicely with Bank of (inaudible).


Your next question comes from the line of Matt Summerville - Keybanc.

Matt Summerville - Keybanc

Brad, can you qualify the hit you took on excess (inaudible) inventory and some of the investments you're making in the fleet? What did all that sort of cost you in the quarter?

Brad Richardson

Well, Matt, I mean, I think if you look at the overall margin performance and kind of the trend that we had been on, what I'd ask you to do is just kind of assume the trend that we have been on.

Now again, first quarter was maybe a little stronger than the historical trend but take that historical trend and then (inaudible) versus what we actually delivered and that's really the impact.

Matt Summerville - Keybanc

And then the level of investment you're making in infrastructure around the Integrated Services organization, how long will these investments you're making sort of suppress margins somewhat, if you will?

Brad Richardson

Yes, I mean, I think again, implied in our guidance is that the margin performance for the service side of the business will be up certainly from the performance that we delivered in the second quarter because again of the high investments.

But those investments will continue for the rest of this year I think is a fair assumption. But again, we're guiding to relatively flat service margins.

Again, second half will be up slightly but it'll still be burdened by some of this infrastructure investment as we formally launch the Toronto Dominion contract.

Thomas Swidarski

And Matt, if I may add one comment there. So our expectations we would enter – exit the year, I should say, in the first quarter north of 28% relative to the service margins.

So I would say the second and third quarter would bear the biggest impact relative to the immediacy of kind of the building of infrastructure.

And if I could explain that for a minute, it's basically because of the level of sophistication associated with Toronto Dominion but also because of the growing book of business there. The decision we made was really to invest significantly to have a capacity to allow us to expand kind of into the future.

So I would call it the step function investment. So it's one that really should be able to carry us for several years after this and be cutting edge and also give us, again, competitive advantage

So while it's going to impact us I would say maybe materially in the second and third quarter in terms of margins, we would see sequential growth from this point in terms of margins and more importantly, give us really good confidence in our ability to handle the increased volumes that we're seeing as Toronto Dominion gets layered on and global sophistication that we'd want to manage that business going forward.

Matt Summerville - Keybanc

Hey, Tom, just one or two other things; can you update us as to what the total contract value is that you have now just in the ATM business? You gave us the security business.

And then can you also help us with how we should think about mix? You provided a bridge, essentially, from Q1 to what you just reported in Q2 as we move from here to Q3 and Q4 on the product side, obviously, how should we be thinking about mix relative to this quarter?

Thomas Swidarski

Hey, Matt, would you frame the first part of your question again? Were you talking about Toronto Dominion or were you talking about something different?

Matt Summerville - Keybanc

No, just the total ATM file value or Integrated Services backlog. It's a number you've given before

Thomas Swidarski

Yes, I think the contract value in the second quarter was about $100 million total contract value and the backlog now is getting close to half a billion.

Yes, so that would be the – and think of that spread over the three or four or five years of (inaudible) contract what we haven't revenued yet but we'll revenue over that period of time, so contracts we've already signed and there lies the issue relative to making sure we've got the right infrastructure in place to be able to both to kind of processes along with the technology in place to handle the volumes that we see coming down the pike here, 2013.

Matt Summerville - Keybanc

And then just on a mix the back half of the year?

Thomas Swidarski

Oh, mix on the back half of the year? It would be – if you're looking at North America, the mix clearly starts waving toward the nationals and maybe that's 55, 60, 40 national to regionals and then you see a higher mix of international, as well.


Your next question comes from the line of Gil Luria - Wedbush Securities.

Gil Luria - Wedbush Securities

Orders overall, it sounds like US orders still up and a few other regions, they were down. Overall orders, how are they year over year and what do you expect for the rest of the year in terms of how orders are going to come in?

Thomas Swidarski?

Yes, so, Gil, the way I would think about that is in the quarter itself, down slightly, but when I look at the full year, I would say orders are going to be up very consistent with revenues. So obviously each quarter brings its own unique comparisons and likewise int eh third quarter, I would see very significant growth in orders but again, a lot of it has to do with timing and we can even that out over the course of the whole year. We'd say double-digit order growth kind of scenario.

Gil Luria - Wedbush Securities

Got it and then it comes to that mix shift in the US, regional banks appear to be coming off the highs from ADA pretty quickly. How long do you expect that decline to go? How much further down would regional banks go? Is the rank the nationals going to be enough to offset that? Are we looking at a possibility of declining revenue next year in North America?

Thomas Swidarski?

Next year, I'm not sure I can really answer next year. I think I would answer that maybe because I don't have enough information here but I would say Gil, when I think of this year, I would say that the strength in the nationals combined with where we're at in regionals should put us in very good stead and be basically flat.

The one thing I would suggest is that as a result of ADA pulled a lot of the orders in from the second quarter to the first quarter and the revenue obviously was impacted dramatically, as well, but I would say going forward I would expect order entry to begin climbing again for the regional bank space in that the second quarter was more of a breather in the market than there was any significant material change there.

So I would expect for us, regional bank performance to be, from a historic standpoint, relatively good. It's just when you're coming off the kind of level we had in the first quarter, we're just not going to really see any kind of activity like that for many, many years but I feel very good about the order activity in the regional bank space and again, it began to climb from where it was int eh second quarter. (inaudible) the nationals to be even stronger. I think that's the message.

Gil Luria - Wedbush Securities

And then finally on security, you're expecting to turn that into growth, into positive growth in the second half of the year. Is physical security stabilizing? Is it electronic security is going to grow fast to compensate for the declines in physical security? Is that going to stabilizing at this point?

Thomas Swidarski

Yes, I would say in essence, the physical security is pretty close to what I'd call stable now. So the growth trend is going to be electronic security growth and again, we looked at that and we feel pretty confident in that 1% to 4%. We said that all along. I know when you look at that number, you say gee, we haven't been able to hit it yet but again, there's new hope for the second half of the year.

These are mostly orders in hand and we're executing against and we feel very good in the 1% to 4% range and as I mentioned on the call, the more important piece is that we're seeing some real traction there on electronic security side with the banks and mentioned two significant banks where you get recurrent revenue streams now with long-term contracts that while they may not make an impact here for each of the next two quarters, long-term that's very sustainable and good margin business when you talk about monitoring on the security front.

So we're pleased with the kind of activity there and like we said, we moved from about $4 million to $10 million. Getting small numbers but gives me confidence in the trend that we should see good performance in 2013, which is probably the most important trend on that.


Your next question comes from the line of Julio Quinteros - Goldman Sachs.

Roman Leal - Goldman Sachs

Question on the guidance; just wanted to clarify perhaps what, if anything, surprised you during the quarter? So obviously currency headwinds and the macro (inaudible).

It is what it is, but plus the increasing investments and even the mid-shift between regionals and nationals, did any of that surprise you? Maybe it was the mid-shift a little bit quicker or give you increasing measurements a little more than you expected originally?

Thomas Swidarski

No, I would say that wasn't a surprise. There are two discreet factors. One you mentioned is currency. The one that was the surprise of the information, that was really Brazil. Had to do with kind of the Brazil elections and impacts for the full year.

So really outside of that, the first half of the year would be kind of in line with where we kind of said was the first and second half would be pretty even this year and now we think the fourth quarter's going to be a little bit bigger because of the movement out of the third quarter relative to the Brazil elections So I'd say overall, some in – put some takes in and out but nothing really of any dramatic surprise.

Roman Leal - Goldman Sachs

OK, and in relation to Brazil, what was the reason for the push-out and what degree of comfort to you have that the order will actually come in in the total time frame you provided?

Thomas Swidarski?

Yes, so the push-out was they're running elections in October and so I don't know if your remember but early on, we mentioned they had a changing of the guard there. We had basically the commitment of 90,000 and we had placed a hard order for 35,000. As they started unfolding the year, they came to us and basically said look, we're not going to do any other orders before the elections.

The elections are in October, so we have expectations then in the December time frame to receive an additional order and while you're never 100% sure, we have some direct conversations with them. We feel pretty confident about the ability of that occurring, so that's our expectations before the quarter order.

Roman Leal - Goldman Sachs

And one last one on AMEA; what's the plan there going forward and how can we expect you to grow that business from here getting (inaudible) taking there?

Thomas Swidarski?

Yes, OK, so I think there's two aspects. One is we've been very, very focused on the profitability side of the equation. So as such, as we indicated, there's what countries we're focused on. We got out of certain countries and try to get out of some cost structure there.

You saw the actions we have taken over the year and I think it's paying off by the performance both not this quarter because we had profitability but even last quarter in terms of improvement year over year. So the trend there is positive. We continue to manage that very closely.

The second piece is when you look at it from an overall standpoint, despite getting out of certain countries and moving the organization around, our order entry has been reasonably good and I think a full year to be pretty comparable to last year with difficult economic environment.

So the other piece of that is so we have certain countries we have some strength in. The UK happens to be a country where quite frankly, we've not been a player at all and so that was a market where we felt given the size of the banks and the impact they have from a global standpoint.

And the conversations we had had that we had been working with some of them that we had developed a product oriented to that market that we unveiled to the market. We brought in a leader that has been a banking expert there for the last ten years with one of the biggest competitors in the region and we also have additional infrastructure we've put in place.

So my expectation in the UK would be an important player for us going forward along with what we do kind of in Brazil and Italy and in Belgium, South Africa and some of those key countries in addition to Turkey, so really the area that probably we have the weakness from in terms of Eastern Europe.

We don't that changing here for us in the short term but we've got those other countries where we think the opportunities are pretty good and with the leadership we've put in place, we feel very good about not only profitability but being able to start looking at some growth here in 2013.


(Operator Instructions) Your next question comes from the line of Michael Kim - Imperial Capital.

Michael Kim - Imperial Capital

Just first off on the tax rate guidance, could you help us understand a little bit the balance of the year, especially considering the mix of regions that drove it up through the higher tax revenue second quarter? Thanks.

Brad Richardson

Yes, Michael, let me answer that. Again, I think the 34% tax rate that we had in the second quarter brings the year to date non-GAAP tax rate up to about 28%. As we look to the full year, we're guiding around 27%.

And so I think you could see in the second half of the year, it'll be slightly lower tax rate than where we are on a year to date basis and that's really driven by again, all the discussion that we just had on what's happening to the profitability of the North American business with more national bank revenue which again, comes in at a lower margin, so that's really what's driving the overall tax rate down slightly in the second half of the year.

Michael Kim - Imperial Capital

And then just turning to electronic security, more of a strategic question. I think looking at Stanley (inaudible), they've been pretty active in acquiring and consolidating a number of security companies over the past few years. How do you guys feel about your organic capacity versus having (inaudible) or perhaps looking a little bit more substantial than that?

Thomas Swidarski

Yes, I'll start (inaudible) couple things. Let me first talk about the organic side. One of the things you'd look at and tear our business apart, you'd say hey, in North America, which is what we're talking about really in electronic security, we see self-service historically at 50, 60-plus percent market share.

We see the same thing in physical security. As a matter of fact, physical security was probably 60% or 70% and then you see electronic security as a share of the financial marketplace with less than 10% in (inaudible) 70% (inaudible).

First of all, the opportunity we kind of focused on was really focusing on the financials. I mean, the financial industry with electronic security and we really started moving in that direction aggressively over the past, say, a year, and we took one of our key folks that sold Integrated Services and put them over on that side of the house and say you're going to do that electronic security firm.

So I'm really pleased with the Regions and BBT kind of conversation that we've got major top 25 banks that are looking to us to do that which is evidence to our capability there.

Then the second would be that we brought Tony over to run the business because of his experience and capabilities and so we'll have the ability to tweak our strategies as we move forward and clearly, we don't need Tony to help us in the financial space; we need him to help us in all the other commercial spaces along with his experience on the M&A side.

So I would say for us, we think about them as small global acquisitions. We want to make sure that we've got the core of our company focused and running clearly in the financial space and then to take advantage of some of the experience we have with some of the major type of enterprise-wide projects but first things first.

We want to get financials running and then we'll start looking outside the financials to increase our capabilities there and we feel like we have the skill sets, we have the competencies to put the right organization in place and now has the right leadership.

So we're going to be patient with this. We think it's a big market with a lot of opportunities going forward but it's opportunities from an (inaudible) standpoint avail themselves, we'll do those prudently.

We're not going to acquire for the sake of acquiring (inaudible) capabilities or (inaudible) that we don't have today (inaudible) right parts. So we'll watch that very closely but most importantly, our confidence in building from 1% to 4% this year is solely based on the financial sector and then as we go forward, I'm hoping that we should start seeing capabilities growing in double-digits here in 2013, '14, '15 in the electronic securities space.


Your next question comes from the line of Paul Coster - JPMorgan.

Paul Coster - JPMorgan

My sense is that you expect the Brazil electoral systems business to shift into 2013. That said, it's after the elections themselves, so is there any urgency in Brazil or is it possible it shifts back into 2014 and beyond?

Brad Richardson

No, the contract – the way this commitment is written is that if they don't order those this year, pricing, certification, everything else goes out the window, so that's something they don't want to put themselves through again.

So their sense of urgency is taking advantage of a pretty favorable contract which we got some assurance of that they will do this year and for us, it means the order would be then December revenue next year but they've been on kind of the mindset of saying look, we're going to replace numbers of these each and every year. Thus this becomes much more of a recurring business and I think this is just part of that strategy.

So we feel pretty good about – our confidence is pretty high in terms of what's going to happen next year relative to the revenue (inaudible) involved in ordering (inaudible) in December.

Paul Coster - JPMorgan

There's a sort of strange data point last week regarding Bank of America's intentions around it's off-premise ATMs and withdrawing a number from the market. Can you just sort of comment upon that? Is it something that we should be concerned about more broadly regarding national accounts?

Brad Richardson?

No, I think for us it's actually a good (inaudible) so for us, the movement in terms of the off-premise locations are much less technically competent types of ATMs, so to speak and so in Bank of America's case, they're looking for the kind of functionality and service contracts and capabilities that we can provide where you're talking about taking cash, checks, recycling, availability in the 99% range.

So the off-site terminals, much more likely (inaudible) market, which is a market we really don't participate in. So for us that was really a place that impacts through our competitors who play in that space but really doesn't impact us in any manner since we're really focused on the functionality and the service side and services side of the business.

Paul Coster - JPMorgan

And lastly, I apologize if you've already answered this but just (inaudible) for the remainder of this year, it sounds like it's going to be heavily back-end loaded, I assume, in India and (inaudible) service contracts but correct me if I'm wrong there but in addition, should we expect sequential growth in the third quarter?

Brad Richardson?

In terms of – I assume you're saying sequential growth from an EPS standpoint?

Paul Coster - JPMorgan

EPS and revenue, that standpoint, yes.

Brad Richardson?

So I would say through sequentially no, you would see really the fourth quarter bearing the bigger growth relative (inaudible) EPS to get us to our guidance, so third quarter would be down sequentially in that regard. From a revenue standpoint, we're relatively flat.


At this time, I'd like to turn the call back over to John Kristoff for any final or closing remarks.

John Kristoff

Thanks, (Deanna), and thank you, everyone for joining us this morning and as always, if you have any additional or follow-up questions, please feel free to reach out to me directly.


This does conclude today's conference. We thank you for your participation. You may now disconnect.

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