Diebold Nixdorf Inc (DBD) 2005 Q2 法說會逐字稿

Good day, everyone. Welcome to the Diebold Inc. Q2 2005 financial results conference call. Today's call is being recorded. At this time, for opening remarks and introductions, turn the call over to the Vice President of Investor Relations, Mr. John Kristoff. Please go ahead, sir.

Thank you, Amber. Good morning, everyone. And thank you for joining us for Diebold's second quarter conference call. Providing remarks today is Wally O'Dell, and Greg Geswein, Senior Vice President and Chief Financial Officer. Also with us today and available to answer questions is Eric Evans, President and Chief Operating Officer.

Just a couple of items before we get started on today's call. The replay of this conference call will be available today at 1:00 p.m. on our website as well as via telephone at area code 719-457-0820 and the pass code is 276504.

Also as a reminder, some of the comments today may be considered forward-looking statements. As a precaution, we refer you to the more detailed information filed with the SEC. Now with opening remarks, I'll turn it over to Chairman and CEO, Wally O'Dell.

Thank you, John. Good morning, everyone. Thanks for being part of our call today.

I'm clearly disappointed with our profitably during the quarter. Despite very strong product revenue growth in our financial self-service business and in our security business and election systems division. Our total revenue from continuing operations in the second quarter increased 15.3% on a GAAP basis. And 12.4% on a fixed exchange rate basis to $629.2 million.

Excluding the previously announced restructuring charges and European start-up costs and related issues, second quarter earnings per share were $0.54 down from $0.60 from the prior period. Total financial self-service revenue grew 11.7% or 8.0% on fixed exchange rate basis, led by 19% product growth. Financial self-service revenue growth was somewhat impacted by disappointing revenue performance in North America as growth in upgrade and replacement activity has been slower than expected, particularly within the regional bank segment.

However, we're encouraged by the strong financial self-service growth in the Americas as demand for upgrades and replacements remain strong despite the slightly lower than expected revenue growth during the quarter. In addition, we achieved financial self-service growth in AMEA of 14.2% and 10.8% on a fixed exchange rate basis, as acceptance of the Opteva significantly ramped up during the quarter.

Asia-Pacific self-service revenue grew a dramatic 57.9%, or 54.7% on a fixed-rate basis due to large order fulfillment in India and Thailand. Security revenue grew 25% in the quarter, or 24.1% on a fixed exchange rate basis. This was due to a combination of continued organic growth in our base business as well as the successful integration and strong performance by our recent acquisitions.

We're poised to continue our strategy of growing this business through market share gains, new markets, and strategic acquisitions. Particularly outside the United States.

Election systems revenue was in line with previous guidance for the quarter, but we have revised full-year revenue expectations upward, due to significant orders in Ohio, Utah, and Mississippi. We also concluded our detailed analysis of the previously discussed reconciliation issue in our North American sales commission accrual account, which was determined to be underaccrued by $13.2 million at December 31, 2004.

First quarter 2005 commission expense was overstated by $1.8 million. While actual commission expenses in the second quarter of 2005 were higher than expectations included in our prior second quarter earnings guidance. This resulted in the first quarter earnings per share being revised upward by $0.01 and first half 2005 earnings per share of $0.99, excluding special items, in line with our previous guidance.

Looking forward to the third quarter, we expect revenue to increase 9 to 11% on a fixed exchange rate basis, with good performance across all businesses. Currency effect is expected to be approximately 1.5% favorable, versus the prior year period. Financial self-service revenues expected to increase 7 to 9% on a fixed exchange rate basis, while we expect security revenue to grow by 10 to 12%. Elections systems revenues expected to be 35 to $45 million during the quarter as Ohio continues to move forward.

Based on these assumptions, we expect earnings per share to be in the range of $0.62 to $0.67, excluding restructuring and special items. This compares to $0.67 in the prior year period. For the year, we're planning on consolidated fixed rated growth of 10 to 12%, with an additional 1.2% from currency. We expect financial self-service fixed rate growth of 6 to 8%. We expect the security business to grow 17 to 19% on a fixed exchange rate basis, and the Election Systems business to generate between 115 and $125 million in revenue. And Brazilian lottery systems revenue of 10 to $20 million.

While we're encouraged by the continued strong order growth for Opteva, we continue to face challenging pricing environment and unfavorable revenue mix as our lower margins security and voting businesses continue to grow faster than financial self-service. As well as the lower margin international segment within financial self-service. As a result, our current full year earnings per share guidance is $2.60 to $2.70, excluding restructuring and special items. This compares to earnings per share of $2.54 in 2004.

We have a number of initiatives underway improving our cost structure moving forward and now expect restructuring charges of approximately $0.30. These initiatives include additional realignment of our manufacturing, infrastructure, further consolidation of research and development efforts, and the merging of software functions and combining the various service functions to better leverage existing resources.

In addition, we have created a strategic pricing management function internally, and believe we can create value by taking a more strategic and disciplined approach to global pricing and discounting. We have implemented several small targeted price increases and will continue to try to achieve higher prices and margins. We have also recently strengthened our discounting policies and we are examining a number of methods to more directly link our sales compensation with gross margin.

In conclusion, we remain confident in the long-term growth prospects in our markets, in our ability to continue to deliver superior performance. Acceptance of Opteva continues to strengthen. It appears the market for upgrade and replacement activity will remain good over the next several years, despite getting off to a slower start this year. And now I'd like to turn the meeting over to Greg Geswein, our CFO.

Thanks, Wally. Good morning, everyone. As Wally said, we were disappointed with the overall results for the quarter. While revenue was strong at $629 million, up 15.3%, from the second quarter 2004 profitability was down.

Earnings were $0.47 per share, versus $0.60 per share reported in the second quarter of 2004, within the most recent guidance of $0.47 to $0.50 per share. Included in the results are approximately $0.03 per charges in restructuring charges and $0.04 per share in European Opteva manufacturing start-up costs and related issues. Our restructuring charges of the approximately $0.03 per share related primarily for the previously announced closing of the Danville facility restructuring of a number of North American organizations and further realignment of the operations in Western Europe. Excluding the impact of these charges, diluted earnings per share in the second quarter would have been $0.54 per share and in line with previous guidance.

We did report solid order growth in the high single digit range, led by double-digit growth in Europe. This was again a record second quarter in 2004. Opteva has done a significant percentage of the global ATM orders, with nearly 131 million in orders in the quarter, with about 60% of that amount coming from the international locations. This is the highest quarter for Opteva orders, and the fourth quarter in a row with $100 million or more in Opteva orders. As noted, second quarter revenue was a record $629 million, up 15.3% on a GAAP basis, and 12.4% on a fixed exchange rate basis.

The positive currency impact in the second quarter was approximately $14 million, or 2.6% versus the prior year. The financial self-service revenue grew almost 12% on a GAAP basis and 8% on a fixed rate basis. Again, this was led by strong growth in Asia-Pacific and Amea.

The security business was up double digits for the 15th quarter in a row as a result of recent acquisitions and strong internal growth. The elections systems business increased 21% to $33 million this quarter, as a result of strong shipments in the state of Ohio. Total gross margin for the second quarter was 25.4%, compared to a particularly strong 29.8% in the second quarter of 2004.

Included in total costs of sales in the second quarter 2005, was approximately $3.1 million of restructuring costs, and $3 million of European Opteva manufacturing start-up costs and related issues, which adversely impacted total gross margins by one percentage point. Our product gross margin was 27.4%, versus the 35.4% in the second quarter of 2004. Again, excluding the restructuring charges and one-time special items, product margins would have been 29.1%.

We also experienced a significant mix shift in the quarter. With the heavier mix of revenue derived from lower margin businesses, than the second quarter versus the second quarter of 2004. This includes a higher percentage of national account revenue in the United States, a greater mix of lower margin international revenue, particularly from India and Thailand, and increased revenue from the security and election systems businesses.

Service gross margin was 23.4%, a decrease of 1.2 points from the 24.6% in the second quarter of 2004. This decline was primarily the result of increased fuel costs. Included in the service costs of sales in the second quarter of 2005 was approximately $600,000 in restructuring charges, and $200,000 in special charges, which adversely impacted service gross margins by approximately 0.3 percentage points.

We have achieve the excellent leverage on the operating expense line. Total operating expenses as a percent of revenue 16.6%, down from the 17.9% in the second quarter of 2004. Improved leverage of selling general and administrative expenses was achieved due to aggressive cost controls and personnel costs and continued the corporate-wide efficiency program. Reduced R&D expense resulting from ongoing product rationalization created by the Opteva rollout accounted for the balance of the improvement.

Operating profit was 8.8% of revenue, down from 11.9% in the second quarter of 2004. Included in the financial results was $6.7 million of restructuring charges and special items, which adversely impacts operating profits by 1.1 percentage points. Excluding the impact of these charges, the operating profit margin would have been 9.9% in the second quarter of 2005.

Other expense and minority increase increased to 7.6% in expense for the quarter from the $2.1 million expense in the second quarter of 2004. This increase was due mainly to the impact of higher foreign exchange losses of $2.7 million in the quarter and higher interest expense due to higher interest rates. Net income was 5.2% of revenue, compared to 7.9% in the second quarter of 2004. Decline in net income as a percent of revenue was partially offset -- partially the result of restructuring charges of $3.5 million and $3.9 million in special charges. Excluding the impact of these special charges, net income would have been 6%. This decline from prior years was attributed to unfavorable revenue mix. Less profitable geographies and accounts contributed to this decline.

The Company's net debt was $142.2 million at June 30, 2005, compared to net debt of $167.1 million at June 30, 2004. The $24.9 million decrease in net debt for the year was due to the positive impact of 226 million in free cash flow, partially offset by the $75 million spent to repurchase Company stock and $56 million spent in dividend payments as well as $45 million invested in acquisitions, $14 million in foreign exchange impact and $11 million invested in other assets.

In the second quarter, free cash use increased by $5.4 million, from free cash use of $18.8 million in the second quarter of 2004, to $24.2 million in the second quarter of 2005. This increase in free cash use was due principally to higher capital expenditures, which increased $5.6 million.

We did show continued improvement on the working capital side, and DSO was 74 days at June 30, 2005, 18 day improvement from the 92 days at June 30, 2004. Inventory turns improved slightly from 5 at June 30, 2004, to 5.3 turns at June 30, 2005. We estimate that as stock options were expensed in accordance with FSAF-123 the full-year impact in 2005 would be approximately $0.07 per share. The new effective deadline for adoption of 123R, the first annual period beginning after June 15, 2005, and while we have not quantified the impact of adoption, we do intend to implement this this the first quarter of 2006.

As previously announced, the Company identified a reconciliation issue in its North America sales commission accrual account. A detailed analysis of this reconciliation has been performed, and the Company identified the reconciliation issue in its North American sales commission accrual accounts, a detailed analysis of this reconciliation has been performed, and the Company has determined the commission account underaccrued by $13.2 million at December 31, 2004, and $11.4 million at March 30, 2005.

First quarter of 2005 commission expense was overstated by $1.8 million. The commission expense in 2004 was understated by $0.3 million, with the first and second quarters of 2004 each understated by less than $0.1 million. Commission expense was understated by $2.7 million and $1.5 million in 2003 and 2002, respectively.

The remaining $8.7 million understatement of commission expense was represented to periods prior to fiscal year 2002. As a result, the Company intends to file an amendment to the its first quarter 2005 form 10-Q and amendment to the 2004 form 10-K. All prior financial information presented in this release reflects the changes from the correction of the North American sales commission accrual account.

Wally has summarized the outlook for the third quarter and full year, and I have just a couple of additional comments. Depreciation and amortization expect to be approximately $20 million, within the effective tax rate of approximately 32%. Of the pension expense expected increased by a penny per share in the third quarter of 2005, as compared to the third quarter of 2004.

My expectations for the full year 2005 include double digit revenue growth of 10-12%, on a fixed exchange rate basis, and depreciation and amortization is expected to be approximately 75 to $80 million with an effective tax rate of approximately 32% as well. The pension expense is expected to be $0.03 per share higher in 2005. Moving from $0.05 per share of expense in 2004, to $0.08 of expense per share in 2005.

Research and development will be approximately 2.5%, similar to the prior year. And as Wally noted, EPS will be in the range of $2.60 to $2.70 excluding restructuring and special items, and the gain from sell of campus card business. For the cash flow guidance, we now expect free cash flow to be in the range of $185 million to $225 million for the year, reflecting the reductions in the earnings for the year. And with that, I'll turn it back to John to open it up for questions.

Thanks, Craig. Amber, we can take our first question, now.

Thank you. [OPERATOR INSTRUCTIONS]. Please pause a moment to gather our roster. Our first question comes from Matt Summerville of KeyBanc Capital Markets.

First on the restructuring activities that you're undertaking, is this something you expect to have wrapped up in '05 or will this extend into '06? And then I think you mentioned in the press release you expect to yield savings of about $20 million on an annualized basis, when do you start to see benefit from that? Is that the actual net savings number?

Matt, Wally. What we have in the release is that we expect to get these things all wrapped up this year. There could be more items next year. I mean, we haven't even gotten to that point. What we're talking about is this year's action. We do intend to get it all finished by this year. If there's any delay, some of that might slip the next year. That's not what we have in mind. As far as the benefit, we're getting some of that benefit this year. 7 or $8 million in the numbers. And the full $20 million would be next year's benefit.

Okay. Great. And then if you can maybe talk a little bit about -- if I look at the A.T.M. business, your product growth is very strong. The service growth is not. And at least it hasn't been for the last two quarters. Fixed rate is around 1% or so.

Given all of the new placements that you've had with Opteva or existing platforms over the last 12 to 18 months, with the upgrading replacement cycle, I guess I'm a little confused now that we're 18 months into this, why your service revenue isn't starting to ramp up. Can you reconcile that a little bit?

Sure. You note that our product revenue is pretty awesome. As that surges ahead like that, that hurts your service revenue certainly at first. If we continue to grow at those kind of numbers, it will knock down our growth rate a little bit. We have mentioned that our highly respected competitor in Dayton has gone back after its own service business that it hasn't done in the past. Has won some of that business. So we're doing well in our own and we're having good results in service. Our product growth rate has one impact, and then there has been some success by NCR in re-establishing its own service on its own units in some accounts.

But, I guess then just a quick follow-up on that. You are starting to see if I just hone in on Opteva. You're starting to see maintenance service accelerate on the machine -- on the Opteva machines you've been placing. I would imagine that your retention rate on the service is 100%. Is that a fair statement?

Our service business on Opteva is great. Greg, did you want to add something?

No. Matt, I would concur with what Wally said. One of the things that we see here in North America is that it's a large replacement market. We're replacing much of of our own base. Which doesn't cause the service revenue to grow at all. You get a little bit of kick from warranty over a time period. Pretty much replacing your own service base. We don't see a lot of net new placements, at least in North America. Not a lot of financial institutions expanding in off premise and things like that. U.S. is pretty much replacement market, causing service growth issues in North America.

You mentioned warranty. what's the average duration of a warranty?

It varies all over the map around the world. 90 days in U.S. Internationally, longer.

Okay. Thanks. I'll get back in queue.

Thanks, Matt.

Our next question comes from Kartik Mehta, of FTN Midwest Research

Good morning. Just on a service margins. Obviously having great success in the Amea and Asia from a product standpoint. Is it fair to assume that the service margins in Amea and especially Asia are much higher than product margins as the product converts to more service, that you'll start seeing a benefit later this year and next year from that?

Kartik, I wouldn't want to characterize a product or service margins. In some countries the product margins are very low and the service margins are good. In other countries product margins are pretty good. That's kind of a hard question to answer. But we should be able to improve both product and service margins from this point forward.

We're focusing on price, our plants are full. We're switching over Opteva. We're doing cost reductions. We -- the mix should be better in the other quarters than it was in this particular one. So I think we should definitely see some positive movement from this point forward.

Wally, your thoughts on the North American A.T.M. market? It sounds like from what with you said, the community banks slow growth was just kind of an aberration. We should continue to see decent growth from at least the upgrade cycle as we move forward. Would that be a correct analysis of what you said?

Yes. I would say the first of all, the large bank segment has been excellent. We weren't particularly happy with our regional bank orders in Q2. But the pipeline looks solid. Our forecast looks solid. I think our growth this year is going to be lead more internationally, but we see a solid U.S. market.

Then -- a question kind of in '06. I don't know you don't like to give guidance until October. If you look at estimates for 2006 there is quite a bit of of variation between the high end and the low end. Can you give your current thoughts in '06 and how the restructuring charge come out, and maybe just some color?

Where will you be in October, Kartik, give us a call. We've been pretty locked out on this restructuring program. It's too far out to look. I have not looked at people's guidance out there. We will begin to work and think on that topic over the next couple of months. October is the right time to get into that.

Thank thank you very much.

Our next question comes from Reik Read of Robert W Baird.

Good morning.

Good morning.

Wally, you guys grew the financial self-service side 12% in the quarter and you just commented that the orders looked good, the pipeline is pretty strong. So why guide down at this point? What's the disconnect in that -- it sounds like the business continues to trend positively, yet you're pushing the numbers down. Is there something that --

I'm not sure what numbers you're talking about being pushed down?

If you grew 12% in the last your and guiding 8 to 12%.

You're talking about revenue growth rate. The highly unusual number in Q2, was that Asia number. Don't ever expect to see another 54% growth rate in any region. That was -- that's the difference.

Okay. But from a North America standpoint, --

We're not giving by region. Those numbers by quarter, by region would be consistent. What you're seeing that's unusual is the Asia number.

I was asking a more general number. Not pinning you down on specifics. What you're suggesting North America continues on, you still have some upgrade opportunities within the regional banks. Even though they've delayed a little bit, it sounds like they're moving forward.

We expect solid business trends around the world, the orders, the activity, the backlog is solid. Now we have to find a way to achieve more profitability. So we're focused on booking the right business to fill our plants. We're talking about pricing actions.

We think there is an opportunity to get some price here. I mean, I've read everybody's else's reports. Everybody is suffering from the same flu, down gross profit margins. We're certainly going to do our part.

How much of the install base right now in North America is Opteva? Can you give us what the percentage of revenue was during the quarter?

The second question, I'm ready for.

Yes.

Our -- first of all, we kind of leave Brazil out of the equation. It has kind of a different product set. We can talk about separately. Our orders for Opteva were 72% of the total orders in the quarter for financial self-service products. And -- excuse me, that was the revenue piece. The order piece was 70. So they're both about 70 at this point. That's up from 50% of revenue and 70% on orders in the first quarter. So the transition continues. As far as the installed-based off Opteva --

around 15% in North America.

We don't generally talk about units. I think we've made some unit announcements. There's -- if you're talking about the banks, there's little over 200,000 units out there. I think -- I think you can do that math.

And then just last question. Just in terms of you had mentioned in your comments that you were reviewing the sales compensation to try to get it targeted more to profitability. Can you just describe what it looks like today and what the transition may look like?

Yeah. We have the very simple commissions based on revenue. And since our plants are full and we're not driving profitability like we'd like, we have to get element of profitability into the mix here. There are a number of way to do that, we're looking at some various models. We want to encourage everybody to get as much price as they can. As well as load our fairly full plants with a better mix of profitable product.

Okay. Great. Thank you.

Our next question comes from Bob McDorman of Investment Counselors of Maryland.

Sir, I didn't get your name and your Company.

Yeah, I'm sorry. Bob, McDorman. Investment Counselors of Maryland.

Good morning, Bob.

How are you doing?

Great.

You highlighted India and Thailand, that's lower margin business. Is that most -- is that due to the less complex nature of the machines or is it the price competition?

Well, Thailand can move around a little bit. India is the lowest -- one of the lowest price markets in the world. It's always done on a public bid. You get a business if your the low bidder. It's a pretty brutal environment.

Thailand just happens to have a couple of big orders that we won. It was competitive. And, you know, we're pleased to get the business. What we're trying to point out in general is that the mix of business in this particular quarter was exactly lined up to give us the lowest possible margin. In other words, the nonfinancial self-service versus financial self-service, international, versus U.S.

India and Thailand versus other countries. Large banks versus regional. There was sort of amazing alignment of bad mix. Which we do not expect to see again. Hopefully will not have to see again in our lifetime.

And if you could just in general -- you started out the year obviously, thinks that margins would be better than they turned out to be.

Yes.

Obviously you talked about mix. Surprised a little bit. Have raw material costs and pricing issues surprised you?

Well, not surprised. The pricing environment has been brutal. A lot of costs are, you know, coming against the P&L. I'd say we were slower than we might have been to consolidate certain things. It's been more difficult to achieve certain kinds of internal cost reductions. And those things coupled with the mix have yielded higher revenue and slightly lower profits than we would have originally planned.

Okay. And one last question. You probably won't answer this. [ Laughter ] You threw out a number of about 200,000 machines, Diebold machines in the North America market. Largely a replacement market. Can you tell us how many of those you've replaced?

Bob, that wasn't exactly what I said. I said there is a little over 200,000 A.T.M.s in the U.S. in place at financial institutions.

Okay.

We have a very large share of that business. We feel that we're at least holding that share. But we do not generally talk about units shipped and units replaced. There is a lot of reports out there on that topic that one can look at.

Okay. Thank you.

Welcome, Bob.

[OPERATOR INSTRUCTIONS]. Next we'll go to Jeff Embersits of Cumberland Associates.

Good morning. On your comments on the regional banking, I was wondering is that purely a matter of they're rolling out slower than expected ? Or also some change in the competitive environment?

I think I've mentioned before that in the past some of our competitors were not really focused on that market. They're focused on it now and they are doing better than they were. I would say that's a more natural expectation than what we faced a few years ago. But we continue to do very well in that space. We have great solutions, the customers in the space love it. They love our stuff and the new features that we have. And we expect to continue to do very well there.

Okay. And on the voting side, do you have a guidance number or relative number on where the sort of the break even point is on revenue? And when that starts contributing to the bottom line?

I'd like to tell you that the voting business is solidly in the black this year. And up significantly versus last year's substantial losses.

Okay. And then finally, you mentioned the strategic planning function. Just curious about how you're staffing that and how will that change from the way you're doing things today?

Yes, what we were talking about is strategic pricing. And we do have that fully staffed. We also have an awesome strategic planning group. And between our pricing and planning and management teams, we're going to do a good job running this business.

Okay, great. Thank you.

Our next question comes from the Matt Summerville of KeyBanc Capital Markets.

Couple follow-ups. Greg, I think you mentioned the dollars you spent on buyback in the second quarter. Can you go through how many shares you bought back? Where you were through the first six months. Secondly, along the same lines, what you have left on the authorization? And then whether or not you've been able to be active yet in the third quarter?

In the second quarter we bought $1.1 million shares. We have 600,000 left on the authorization. What typically happens is the Board would like us to use up that authorization. Then we'll meet and they'll consider a new authorization. So that's kind of where we're at now. We have not been in the market yet. We usually like to stay out of the market until about 3 days after the earnings release. We expect to certainly be in the market once the 3 days pass.

Okay. And then if you can provide a little more detail around the increased guidance around the voting revenue for the full year? What the key components of that are and then what your thoughts are on 2006?

As far as the increased revenue, we've -- won a substantial amount of business in Ohio. We've won the state of Utah and won Mississippi. I don't think that was fully reflected in the guidance that we gave you three months ago.

Do you know how much, Wally, of Utah and Mississippi will fall into this year?

Tom Swidarski is here. You can answer that.

Yeah.

As fully as you want.

Matt, we're working very closely with both of those states in terms of the actual rollout. As it stands right now, it appears that Mississippi is fully reflected. They would like to have all of the shipments this year. Utah is still working out the details of how many units this year to comply. And I think in both of those scenarios, that's why you see the range. If Utah all comes in this year, we'd probably hit the top end of the range that was in there. If Utah pushes some of those shipments out, we'll be toward the $115 million level.

That makes sense. Could you, Tom, or Wally talk about your thoughts in 2006? How big you think this business can be next year?

Matt. I think right now I'm going to defer that question from the standpoint there is so much activity going on. So much uncertainty out there right now. Under the original HABA act people were supposed to be compliant by 2006. There's been some interpretations by certain states and the counties, saying, "look, by the first time we run an election in 2006." Meaning that a lot of people looking at things in the first quarter.

This is going to come to light here. Seeing a lot of activities in various states, getting a lot of phone calls from panicked folks. I think over the next several months, we'll have a much better picture of what the outlook is going to be and how that would impact the end of the 2005, but the majority of 2006.

Do you think, Tom, that the '06 date will get pushed out?

There are meetings occurring today in Washington, D.C. on that very subject. So there are so many states that are unprepared at this point. So many counties unprepared at this at this point. So many counties unprepared at this point. I'm not sure how they will resolve the dilemma. The EAC, who is the governing body right now, has given every indication that they're not pushing back on 2006 date.

Okay. And then two other follow-ups. One on security. Can you talk about how much of the growth there was organic versus acquisition? What your expectation would be for the full year on those metrics?

For the quarter internal was 10.

Okay.

I don't have a full year number handy. Okay.

I can follow-up with John after the call. In the Amea region you grew 11% fixed rate. If you can talk about maybe the western European versus non-Western European, business and the outlook for both of those buckets, if you will.

Hold on a second. Yeah, the full year internal growth rate in security would be around 10 as well.

Oh, okay. Thanks.

The first point I want to make is the -- we did say we would grow double-digit fixed rate in Europe in the second quarter for the first time in a very long time. We did. Our orders and backlog are great.

We've had a good mix of eastern European business as well as good progress on all of the certifications in Western Europe. We've gotten good orders in some places that we haven't been before. Which I don't want to mention. But we had good balance success, increasingly successful now in Western Europe.

Great. Thanks a lot, guys.

Thank you, Matt.

Our next question comes from George Nissan of Merrill Lynch.

Thank you so much. Couple of questions for you guys. Over the past year a lot of your competitors have recently been implementing new strategic initiatives to reduce raw material costs by establishing a better line of communication to the supplier base.

Could you provide color to what you planning are doing from now on to reduce overall raw material costs, improve some of your supply chain efficiencies with your Company by opening a better line of communications with your suppliers?

I can tell you we're doing a lot from end to end here. From supplier relationships and qualification to where we produce our product and what components need to be in those products. Eric is here. He has a few comments he'd like to add to that.

We definitely see tremendous opportunity in having a more effective supply chain. Where we work with suppliers to get shorter lead times and we reduce costs. We've got a number of initiatives underway to do that. We are working with Arriba, a company that leads in send-management technology to help us drive out costs out of our supply chain. We do see great opportunities ahead of us to do good in those areas.

The other thing that might help us and might take until 2007 before you see it fully. Getting over one set of global products with Opteva. Reducing, eliminating production of all of the legacy products and the support for some of the old things behind that. There's a lot of benefit from getting that done. We look forward to that.

I have followed your company for the last 4-5 years, quality has been always a huge initiative within your organization. That's why you've been able to see sustainable results. How are you making sure your suppliers are meeting up to your quality metrics. Are you scorecarding them quarterly? Are you meeting with them on a daily basis? What are you guys doing to make sure they're meeting up to your standards?

We're doing that. We have a very active SQE supplier quality checking function. Works with suppliers. We do scorecards with them. We work on mutual areas for improvement. And that's all part of having a good effective supply chain.

Do they feel like they're getting squeezed right now? Or --

There's always a lot of pressure on suppliers to do better in cost and we see that in our markets. So we pass that on to our supply chain.

okay. Final question. Regarding your supply base. You know, you said -- overall, I guess they're not being squeezed. What's been their feedback on the initiative? Are they real open to working with you guys on a partnership? Understanding there are alternatives out there?

I guess I didn't mean to imply that they're not being squeezed. Many suppliers are being squeezed because of the competitive environment we're in. We transmit that to them. That being said, I would say the vast majority of our suppliers, we have very good working relationships, where we both realize we're in it together. And we get good cooperation. Areas of our supply base where we need to improve and find different alternatives suppliers.

I'd say one of the things we need to do as we simplify our product lines and eliminate the old ones and get our supply chain lined up with our new product, is the focus on speed. You know, our quality is excellent. Our cost and -- our excellent, our pricing is competitive. But we need to give a little more price. At the same time, if we can get quicker response time and simpler flowing, that will help us a lot.

There is areas of supply base you're looking to improve on. Could you maybe provide a little color on a few areas that are a concern --

I'm not going to comment on any particular area.

Just say that as we eliminate IX and focus on Opteva. That will give us some opportunities.

Thank you so much, good luck on the rest.

And our next question comes from Colin Campbell of Brookside Capital.

Hi, guys. I have a couple of housekeeping questions. First of all, the other expense items seem to be a little bit high this quarter from the FX, currency loss. That seemed to ding you guys by 2 or $0.03. Do you expect it to continue at this higher level?

No, Collin.

That was directly a result of the drop in the Euro in the quarter. The movement within the quarter caused that.

But the right way to think about it would be rather than staying at sort of an $8 million a quarter level more in the historical 0 to $2 million level?

For exchange? You're talking about the whole line.

The total other income line.

You have to look at that item by item. But the exchange piece of that should drop back to more normal.

Yep.

As we move forward.

That's exactly right, Collin.

Second question is -- some of this in the release, I know. Greg, can you walk us through the income statement and where the nonrecurring expense items fall in terms of COG, SG&A, R&D, et cetera.

Let's see. On the restructuring, there's about $2.5 million, these are high-level estimates under product cost of goods sold. $600,000 under service. There is about $300,000 under OpEx, under special there's about $2.8 million under product. A couple hundred thousand under service. And $100,000 under OpEx, there was one about 700,000 below the line.

Gotcha. And was there any catch-up expense from the North American sales commission resolution?

It -- it was a small negative compared to what we had previously expected. But it was quite positive in Q1 as we also mentioned.

do you have a figure as to what it was in Q2?

Rounds to a penny in Q1 and nothing inQ2.

Okay. Thanks.

And that appears to be our last question of the day. I'll now turn it back to you gentlemen.

Thank you for joining us today, and as always, for any additional follow-up questions, please feel free to contact me directly. Thank you again for joining us.

This does conclude today's conference, you may disconnect at this time.