Diebold Nixdorf Inc (DBD) 2006 Q4 法說會逐字稿

Good day to everyone, and welcome to this Diebold, Inc. 2006 Fourth Quarter and year-end financial results conference call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Vice-President and Chief Communications Officer, Mr. John Kristoff. Please go ahead, sir.

Thank you, Bill. Good morning everyone, and thank you for joining us for Diebold's fourth quarter and year-end conference call. Providing remarks today are Tom Swidarski, President and Chief Executive Officer, and Kevin Krakora, Executive Vice President and Chief Financial Officer. Just a couple of notes before we get started. The replay of this conference call will be available later today from our website. As a reminder, some of the comments may be considered forward-looking statements. As a precaution, we refer you to the more detailed information that has been filed with the FCC. And now with opening remarks, I will turn it over to CEO, Tom Swidarski.

Thanks, John. Good morning, everyone, and thank you for participating in our call this morning. I'm pleased with the progress we demonstrated in the fourth quarter, which is a testament to the continued dedication of our employees. I would like to briefly review the progress this management team has made over the past year, review key issues in the business during the fourth quarter, and share our view on 2007 and beyond.

Last year at this time, we certainly knew we had our work cut out for us. We were face wad number of major operational issues that require decisive action. We quickly identified the key drivers to improve our performance and built a three year recovery plan around five key priorities. To improve customer loyalty, develop and refine our supply chain, improve the the quality of our product and services, enhance internal communication and teamwork, all of which lead to our ultimate priority of rebuilding profitability. While we continue to focus on the priorities, I am pleased with the progress we made on all of these fronts with the continued support of our employees, customers and investors. I would like to spend a few minutes reviewing the operational actions we have taken to address our supply chain and quality issues.

Organizationally, we made two major changes aimed at driving a greater level of accountability in this space. We combined procurement, manufacturing engineering, and production operations into a single group under the leadership of George Mayes to ensure these areas work together seamlessly, to improve quality, and enhance efficiency. We also combined our financial self-service engineering and development and service functions globally under the leadership of Chuck Ducey. This alignment has led to improve product quality and reliability, and we are beginning to see the results in improved service gross margins.

As a result of these organizational changes and a renewed focus on improving our operations, we were able to quickly target $100 million in cost savings over a three year period. We've already begun to see some tangible benefits and results in this program, as evidenced by improved margins in the last two quarters. These results speak to our intense focus on enhancing the quality of our solutions and stabilizing pricing, as we continue to reduce our cost structure. And as of year-end, we eliminated $12 million in expense from our cost structure going into 2007. We have identified an additional $23 million in costs that I'm confident we will eliminate this year, keeping us on track to achieve our corporate operating margin of 11% to 12% in 2009.

Another key initiative we announced in April is the realignment of our global manufacturing operations. This included the opening of a new facility in Budapest, Hungary, which began production on schedule in the fourth quarter. We produced about 1,000 ATMs, achieving the same level of quality as our more established plants in Asia and Americas, while achieving a 98.5% on-time delivery rate to customers. At the same time, we moved forward with the planned closure of our facility in Cassis, France. More recently, we ended all production at the Cassis facility and officially notified the majority of the plant's workers of the termination of their employment. While one of the unions is legally challenging this action, we expect this process to be complete by the end of the first quarter. We understood the level of difficulty associated with this initiative when it was first announced. However, this action is critical in achieving the supply chain improvements needed to restore our profitability. And we are just a steadfast in finishing this process now as we were when we started last April.

In addition, we just signed a memorandum of understanding regarding the sale of the facility, which we expect to close in the next few weeks. Once we complete this action, I believe we will have an optimal manufacturing footprint with low cost locations in Hungary, India, Brazil and China. In North America, we will have reduced our manufacturing facilities from seven to three since 2003. And I feel we still have significant opportunities to reduce manufacturing costs and build a more competitive cost structure. By maintaining control of our manufacturing assets, we can achieve the differentiation in our value added processes that our customers demand, specifically in terms of responsiveness, quality, and service. Our savings will be achieved by reducing material costs through lean design, and further improvements to our global supply chain.

On another front back in June, we assumed direct control over our vital information systems, including the implementation of support responsibilities of our global ERP system. This remains a top priority for us. During the year, we resolve system performance and stability issues, made fresh investments in the Ohio data center, and added a new center in India that offers 24 by 7 support and development for our Oracle systems. In addition, we recently added new executive management with considerable expertise in IT strategic planning, business transformation, and global Oracle ERP system implementation.

We have also made substantial progress in our evaluation of our ERP implementation plan and are impairing a portion of our ERP asset. Kevin will provide more detail on this during his commentary. We anticipate that with our continued commitment in investment and resources, we can have the ERP system fully deployed by late 2008, early 2009. To remain competitive in an increasingly global environment, it is imperative to have an internal system and infrastructure to effectively manage our business, which is why we will continue to invest significant resources in the space.

On the organizational front, we made significant leadership changes in September within our international operations. I wanted to remove barriers, share more resources across countries, and bring a greater focus on the customer. James Chen now leads all sales and service operations in the EMEA region, in addition to his previous responsibilities heading our Asia/Pacific operation. Joao Abud now oversees our sales and service operations throughout all of Latin America, in addition to his leadership responsibilities in Brazil. Our international operations have evolve from a country-based management structure to a regional-based structure. This allows us to leverage employees across boundaries, implementing best practices, and further improving our strength in each region.

As you can see, the pace of change with the Company is rapid. We're moving in the right direction and making the right decisions to bring focus back to the customer and improve our competitive position in the marketplace, resulting in long-term profitable growth. In addition to continuing work on our key operational initiatives, our focus in 2007 will expand to enhancing and broadening our product and service solutions set. I will talk more about development on both of these fronts later in my comments. But first, let's review the progress we've made in the business segments during the fourth quarter.

Within the financial self-service business, I am pleased with the product gross margin improvement that continued during the quarter. Improved pricing discipline in North America, a lower cost structure and more favorable geographical mix within Latin America contributed to improved product and service margins. In addition, we were also able to hit our fourth quarter service gross margin target of 22%, excluding restructuring, as Opteva quality and reliability levels continued to improve. In fact, the product is consistently performing above engineering specifications.

Looking forward, there are a number of factors that will influence our future success in financial self-service. First is the area of deposit automation. After extensive discussions with customers of various sizes, I can tell you that this is a subject that is top of mind. While we don't believe the deposit automation will drive significant growth in 2007, I'm more confident than ever in the adoption of this technology. Diebold is uniquely positioned to capture a sizable piece of this opportunity with our extensive experience in developing and servicing check imaging technology at the ATM. Over the past 15 years, we have introduced five generations of our own check imaging technology, and have deployed more than 3,500 check imaging devices at the ATM in the United States alone.

Recently, we announced a licensing agreement with Data Treasury that protects us from certain potential patent infringement claims in the check imaging space. We are the only ATM supplier that has a licensing agreement that expressly protects our customers from Data Treasury patent infringement claims based upon your use of Diebold solutions. This will be important moving forward as we continue to develop and introduce new check imaging solutions. In my conversation with customers last year, I learned that a bulk check imaging solution at the ATM is increasingly becoming a market requirement. In November last year, we introduced a working prototype of a bulk check imaging module that has received very positive customer feedback. Our 15 year history in developing and delivering quality check imaging devices will enable us to take this solution to the market quickly and successfully.

Our deposit automation strategy is not limited only to the ATM. Last year we acquired Aris, a leader in the payment processing and document imaging capabilities. With Aris, we have the capabilities to do check image capture and processing at the ATM, at the branch, and remotely at customer sites. This, coupled with our ImageWay software solution, now allows us to offer financial institutions a full check imaging enterprise solution. We're currently doing complete check processing outsourcing for more than 50 customers.

Another major focus for us is to significantly improve the competitiveness of our software platform. We've made great strides in improving the stability performance of our Angilis software platform over the past year, which has significantly improved our competitive position in the areas such as Europe. In fact, we now have nearly 100,000 Angilis licenses installed globally. Software is an increasingly important part of our overall solution, and 2007 will be a watershed year marking our competitive presence in this area.

Finally, integrative services present the prime opportunity for the Company as we look ahead. We are well positioned in the space, given the track record of success we've established in Brazil, Canada, and other areas. With the key strategy for us as customers increasingly focus on our core business, we'll rely on outside partners to manage the technological aspects of their operation. This will become an increasingly important tool in our overall strategy to increase the value of our solutions we provide to our customers, rather than just being put into a position where the only perceived differentiation is priced.

Now, turning our attention to the securities space. The security business continued to show strong revenue performance and profit improvement during the fourth quarter. In addition to strong growth in our newest verticals, commercial and government security, we showed solid gains in the financial and retail markets as well. Throughout our customer segments, security continues to be a key issue, and the rapid change in the hardware and software technology are opening up new opportunities for more managed services, especially project management and monitoring solutions. These new IT oriented opportunities have been the drivers of our security acquisitions over the past few years. One example of our investment in new market expansion is the number of Diebold security professionals focusing on the government market. This group has more than doubled since a year ago.

We now have a solid government sales, implementation, and service organization in place that has been met with favorable acceptance in the marketplace. Last week, I attended the 2007 kickoff meeting with this organization, and was extremely impressed with their level of energy, skill, and professionalism. This team closed 2006 with a healthy pipeline of opportunities and is off to a good start in January. As we look to 2007, we hope to accelerate our growth in retail, commercial, and government segments while continuing to grow in our longstanding financial market. We will also continue to globalize our security business in a blended plan of leveraged organic growth and through acquisitions.

Now turning to election systems. We experienced another solid quarter and year with significantly improved profitability. Since our last call, our elections equipment performed extremely well during the mid-term elections in the United States, with more than 150,000 machines in 34 states accurately and securely capturing the vote. The improved profitability of the year in this area is a result in higher revenue on relatively flat cost structure, as well as the lottery and elections business in Brazil, which carry healthy margins. Early this year, we will communicate our long-term strategy related to the elections business.

I mentioned earlier in my comments that our focus in 2007 will expand to enhancing and broadening our product and solutions set. Our strategy is clear. We will remain focussed on satisfying our customers. We will continue the hard work of transforming our Company and improving our business. We will continue to drive and capture opportunities in our markets around the world. During the year, we have a number of key objectives in addition to our ongoing operational initiatives. First, we need to complete our manufacturing optimization plan with the final closure of our Cassis, France, plant. Next, we need to finalize and communicate our long-term strategy for the election systems business. We will also continue to strengthen our deposit automation strategy with the introduction of several new products, and we will significantly improve our software offering in the financial services space. Finally, we will begin to expand and build our integrative services strategy beyond Brazil and Canada. These actions and others will lay the foundation to bolster our competitive position in the markets we serve for years to come.

In closing, the feedback I'm receiving from customers and employees around the world has given me more and more confidence that we are moving in the right direction and making a difference. While it's been a challenging journey thus far, it's also been rewarding. The passion and commitment of our people is terrific, and the support and loyalty of our global customer base is rewarding and humbling. As I sit here today, I'm encouraging with where we are relative to our three-year recovery plan, and I'm confident we have the right team focussed on the right priorities to successfully execute against our long-term strategies. Now, I will turn the call over to Kevin.

Thanks, Tom. Good morning, everyone. We closed 2006 with a very strong fourth quarter. We achieve significant improvement in gross margins, earnings per share, and delivered strong cash flow. I feel these improvements confirm that the Company is focussed on the right operating and financial initiatives necessary to reach its long-term financial goals. In the fourth quarter, we generated free cash flow of $96 million, which brought our full year total to $206.1 million. This represents nearly four times the amount of free cash flow, and that which was delivered in 2005. I'll be provide further detail regarding cash flow later in my comments. However, let me first take a look at the rest of our financial results for the quarter.

Fourth quarter income from continuing operations was $27.1 million compared to $10.4 million in the fourth quarter of 2005. Diluted earnings per share from continuing operations were $0.41 compared to $0.15 per share in the fourth quarter of 2005. As we reported to you in the third quarter, we have conducted an extensive evaluation and review of our ERP implementation plan, as well as our global IT organization, and software and hardware architecture. As a result of this review, we determined that $22.5 million in previously capitalized ERP costs have become impaired, resulting in a fourth quarter non-cash charge of approximately $0.25 per share. This impairment was primarily the result of previous customizations made to software and software related costs that had been rendered obsolete due to adjustments in the implementation plan, process improvements, and the decision to implement a newer release of the ERP software. In addition in the fourth quarter, we recognized restructuring charges of $0.11 per share, primarily resulting from the continued realignment of our European operations. Excluding the impact of the impairment charge and the restructuring charges, diluted earnings per share in the fourth quarter would have been $0.77.

Turning next to orders, on a constant currency basis, financial self-service orders declined slightly. This was driven by continued softness in the America's market and a decline in Asia/Pacific, which faced a difficult comparison to a very strong fourth quarter 2005. In addition, orders in EMEA were up in double digit range from the fourth quarter of 2005. Security orders increased in the mid-single digit range led by Americas, with continued strong growth from the government, retail, and commercial sectors. Total revenue for the quarter was $825.4 million, up 1.8% from the fourth quarter of 2005, with security revenue up 15.8% over the prior year period. These increases were partially offset by an $18.4 million reduction in Brazilian lottery revenue, and a $9.8 million reduction in election systems revenue.

Product gross margin was 28.9% for the quarter, compared to 25.3% in the comparable prior year period. Excluding restructuring charges of $1.2 million in the fourth quarter 2006, and $2.2 million in the fourth quarter of 2005, product gross margins would have been 29.2%, compared to 25.8% in the prior year period. This improvement in gross product margins was driven by increased pricing discipline in North America, a lower cost structure, and a more favorable geographic mix within Latin America.

In addition, improved profitability in the elections systems business also contributed to the improved gross margin performance. Service gross margin was 21.3%, compared to 19.8% in the fourth quarter of 2005. Excluding restructuring charges of $2.6 million in the fourth quarter of 2006, and $1.4 million in the fourth quarter of 2005, service gross margins would have been 22%, compared to 20.2% in the comparable prior year period. This improvement is a result of improved product quality and the related productivity gains which were especially evident within the U.S. market.

On a sequential basis, service gross margins, again excluding restructuring and special charges, continue to improve, moving from 18.4% in Q1, to 19.9% in Q2, to 20.8% in Q3, to finally 22% in Q4. Further, service gross margin in the elections systems business also improved on significantly higher revenue.

Operating expenses as a percent of sales improved moving from 18.1% in the fourth quarter, 2005, to 17.3% in the fourth quarter of 2006. The fourth quarter effective tax rate was 25%, down significantly from the prior year's fourth quarter. This improvement was due to a more favorable mix of income and the successful implementation of global tax initiatives.

As I noted earlier, I was especially pleased with the very strong free cash flow in the quarter. Our free cash flow in the quarter increased by $32.7 million compared to the fourth quarter of 2005, driven by higher earnings and improved cash collections. These higher cash collections drove a six day DSO improvement to 59 days at December 31, 2006, surpassing our target of 60 days for the first time in the Company's recent history.

Also in the fourth quarter, we collected approximately $7 million related to an original total of $32 million of past due election receivables from two counties in California. This $7 million collection, combined with our $11 million collection from the third quarter, has reduced the uncollected balance from $32 million to approximately $14 million. As a result of these collections, approximately $1 million of previously recorded bad debt expense was recovered in the quarter. We will continue to pursue collection of the remaining $14 million.

Net debt at December 31, 2006, was $335.4 million, compared with $241.9 million at December 31, 2005. The increase in our net debt over the past year was due to free cash flow of $206.1 million being offset primarily by share repurchases of $148.1 million, acquisitions of $62.1 million, and dividend payments of $57.4 million.

During the quarter, we repurchased approximately 100,000 shares of Company stock. This brought our full year 2006 share repurchase total to 3.6 million shares. That leaves us with approximately 900,000 shares remaining under our existing board authorization. Our net debt to capital ratio was 23.5% at December 31, 2006, compared with 17.3% at December 31, 2005.

Moving to our 2007 full year outlook, we are expecting total revenue growth of 3% to 5%, which includes financial self-service revenue growth of 2% to 3%, and security revenue growth of 8% to 12%. It is important to note that our financial self-service growth expectations for 2007 are expected to be negatively impacted by over 2 percentage points due to nonrecurring revenues from a single customer in Canada. In addition, we anticipate election systems revenue between $185 and $215 million, and Brazilian lottery revenue between $18 and $20 million.

We expect 2007 capital expenditures to be in line with our 2006 spend levels, and our preliminary estimates for our 2007 effective tax rate is between 28% and 30%. We are expecting GAAP EPS for 2007 in the range of $1.85 to $2.00 per share. Our full year restructuring charges are now anticipated to be $0.25 to $0.30 per share related to the plant closure of the production facility in Cassis. Excluding these restructuring charges, EPS for the full year is expected to be in the range of $2.15 to $2.25 per share.

While our free cash flow in 2006 benefited extensively from improved cash collections and reduced DSO, particularly in Europe, the opportunity for further DSO improvement in 2007 will be diminished. However, with continued operational focus on both DSO and inventory turns, we still expect strong free cash flow for 2007 in the range of $150 to $165 million. This also includes $18 to $22 million of anticipated cash charges associated with the Cassis plant closure.

In closing, 2006 was about making the right decisions for the long-term health of the Company. And although there is much to be done, we have made significant progress in improving our supply chain, in optimizing manufacturing operations, and enhancing our global ERP system implementation, and in strengthening our management team. Moving into 2007, I am optimistic that with a solid balance sheet and continued strong free cash flow, we have the financial resources to make the needed investments as we continue to progress towards our multi-year profit and improvement goals. With that, I will turn the call back over to John.

Thanks, Kevin. Bill, we'll open it up for our first question, please?

[OPERATOR INSTRUCTIONS]. We will take our first question from Kartik Mehta with MTM Midwest.

Good morning. Tom, I wanted to ask you about the securities business. It seem like that business is doing fairly well. Can you talk about just the drivers for that business and what portion now, the nonfinancial part of the security business is.

Sure. Just to repeat that the four business segments we're really focussed on in the securities space goes beyond financial, which is still the bulwark of it. But we've got the retail piece, high end commercial piece, and a government piece. The -- those three components collectively now make up probably 25% to 30% of our total security revenue. And as you might imagine, we're pretty excited about the growth potential in the retail, commercial, and government space. So we are looking for that to continue to grow. We were seeing that we can improve profitability in the acquisitions that we made there that brought in certain expertise. And we are looking very closely at the acquisitions outside the United States to make sure that we can see similar type results. My expectation would be that financial within the next year or two will only represent about half of the overall revenue in security because these other spaces are growing quickly. And I made a mention relative to the government space here in the United States alone with the very increased focus, and the amount of spend there is in the $50, $60 billion range. We are looking at very good revenue, very profitability opportunities, and position ourselves appropriately .

So Tom, will the margins in the non-financial security side be just as good as the financial, or are they better or worse?

With most of the acquisitions, they start out lower. And we have on the front end of this, we have investments to do to get them positioned properly. But the expectation is that we were -- we've demonstrated with some of the recent contracts to be able to get margins that are actually exceeding what we do in the financial space. And again, it has to do with kind of the integrated services and specialty capabilities we can bring to both project management as well as monitoring as well as the other services that surround it that make it a very profitable business for us.

Tom, if you look at the business overall from a geographic standpoint, what geographies do you think have the best opportunity to improve margins?

I would start with EMEA. I would say that in the United States this past year, we made significant progress with the pricing disciplines we put in place, the monitoring, the discounting, and I have seen evidence that -- of that good progress on a quarter-by-quarter basis here in the United States.

In Europe, it's certainly a very large market. You kind of split into two, if you would. You've got the western part of Europe and you've got eastern Europe. But we have not really had the organization in place or the capability from a product service standpoint in place that we're now finding ourselves in position of. We have introduced the software architecture that I think is going to really help us in that market. We've got very good revenue growth this year. But there is still considerable work to be done relative to service margins, as well as improving product margins there. I think with James Chen's leadership and some of the organizational changes we're going to be -- that we've introduced within the region, I think those all bode well for us this year on going forward.

Now the last question, Tom. You talked a little bit about deposit automation and that having an impact at sometime in the future. At least here in the U.S. Just your thoughts on maybe why it's taking so long. Is it taking longer than we thought because of the cost of the equipment, or are there some other issues maybe that are slowing it down?

I think there are other issues slowing it down. Certainly it's a significant investment from the bank's standpoint. But in essence, until their back end systems are in order, you don't achieve the full value of automating on the front end if on the back end you don't have the same level of automation there. Banks have been cautiously moving down the path. But the back end systems really need to be in place, and we're starting to see evidence of that.

The second thing is we're not seeing the pushback at all relative to the adoption and piloting of the devices, and as institutions begin to pilot them, after a three or four month period, they start to get comfortable with what they need to do with the branch operational side. So some the bigger institutions, you going to start to see some more significant rollouts the latter part of this year. Some other ones are still intrigued with this bulk check that I mentioned, and we've gotten some very good feedback there, and I feel good about our unique position with that technology.

And I think lastly when -- with the kind of the credit unions and smaller financial institutions I've talked to, we're seeing a lot of interest in us demonstrating the technology, them coming to other sites, coming here and spending a lot of time with that. And it's just a longer cycle in terms of them adopting it to roll it out because of the change in procedures both in the front office and back office. As I mentioned in my comments, I'm more optimistic about that than I have been at any point in time.

Thank you very much.

You're welcome, Kartik.

We will take our next question from Matt Summerville, KeyBanc.

Couple questions with respect to what you were just talking about around deposit automation in the U.S. and a feeling that the second half of the year is going to be better. Do you actually have orders on the book now in commitments from some of the national or larger sized banks in the U.S. for rollouts in the second half of '07? And to that point, what sort of penetration rates are they discussing with you with respect to check imaging?

For us, we identified maybe 20 accounts that we call the big national or strategic accounts in the United States. We have concrete orders in place for rollout plans with several of these institutions for the second half of this year. And in terms of percentage or penetration rate or whatever you want to term it, most of the folks are viewing -- the folks that are rolling this out at this point are viewing this technology as almost a requirement in their branch locations. So I would see penetration rates across their network, if they have 5,000 or 10,000, I would see penetration rates close to 75% over a three-year horizon.

Okay. That's helpful. Can you talk about then the same -- I will ask the same question about what you are seeing in the community bank market, if you can provide more color there.

Okay. In the community bank market, as you might imagine, the -- a lot of them take their cues from the nationals. By the same token, we have a lot of credit union activity going on right now. We have a lot of small banks, institutions that I would say $5 billion and under in asset size that have an appetite for it. For these folks, that's more of a one, two, three kind of sale, and it's a very focussed effort. But the level of activity there is encouraging. We've communicated it publicly about Suncoast Federal Credit Union, and that rollout's been going on for probably nine or ten months, and that will conclude this year, and so we'll have them installed, 90 to 100 complete deposit automation terminals, which would be almost every single one of their ATM sites. So that's a healthy sign for us. And we see more credit unions and small institutions starting to look at the ROI and look at the value of automating that right at -- right in the branch location.

Just to get a little more specific, how big exactly is that revenue hole you to fill in Canada?

Let's see. In 2007, compared to 2006, we'll be down, I think it's between $50 and $60 million in Canada. We had this enormous outsourcing project with the major institution up there, which is tremendous business for us. Gives us a foothold relative to doing outsourcing in major, major institutions. Revenue last year was, like I said, $50 or $06 million more than we could ever anticipate this year. Thus, that hole we were filling in the U.S. we are seeing, I think for the first time probably in the last five or six quarters, we're seeing projected for this year both the regional account business and financial self-service to be up slightly, as well as the strategic. But it's not up enough to overcome the hole we have in Canada.

Okay. Then if to that point you made, you anticipate the regional and national business to both be up in '07 versus '06. Can you talk about what it was in '06 versus '05 in similar terms that you just described?

Both business were down probably around 9% to 10%, and that was obviously offset by the impact of the Canadian business growing. So that when we looked at it in total, it was probably flat.

So it's actually pretty meaningful improvement in activity level, '07 versus '06 within the U.S.

Correct.

Okay, great. Thank you.

Let's go next to Reik Read for Robert W. Baird and Company.

Good morning. Tom, as per your comments, you had mentioned your desire to significantly improve the competitiveness of this software platform. Can you talk a little bit about what you need to do there? What maybe some of the shortcomings are, and are those shortcomings having any negative impact in terms of equipment opportunities at this point?

Yes. On the software front, I mentioned we have about 100,000 Angilis licenses out there in the marketplace today. The issue we had probably two years ago and that impacted us at the beginning of 2006 was we rolled out a new family of hardware and software, Opteva and Angilis, and Angilis hadn't performed as expected. So as a result, we had to put a lot of service technicians against the software, and fortunately for us, and we have a pretty good staffing model, and we were able to staff appropriately, stabilize that, which I think really helped us in the second half of this year in the United States specifically.

If I look internationally, it's a different software environment internationally where there is a lot of work that needs to be done at a customized level, in an account level. Our software architecture historically was oriented toward a prepackaged solution that fit the U.S. market. We've made significant progress on that as was evidenced in the growth that we experienced in Europe last year, and software was a key component of that. You will continue to see us introduce new capabilities and tools to allow both our professional services organization as well as the bank's software engineers to be able to utilize the software in I think a more user friendly manner going forward. That's the focus. Has it impacted our ability to compete in Europe in the past years? Absolutely. Do I think this will help us going forward? Yes. But in spite of that, you saw last year we probably grew revenue in Europe 20%. It's something that can be overcome, I just want to make sure that we're not just getting competitive. That we're going to continuing to evolve our software architecture to be world class, and we're not there yet.

And will these changes also help you from a service deployment perspective where you can be a little bit more efficient because the software is not causing as many issues or is maybe doing more things to make the machine efficient?

I wouldn't say it's a direct correlation there. I would say that we've got a lot of actions going on the service front, and certainly software has an implication in terms of intelligence built into the unit and the status passed back, but that's really almost a completely separate initiative. We've got a lot of focus on that. As I mentioned before, EMEA is an area, and all of Europe's a region where we think we can make some real meaningful progress in 2007 on that front.

Okay. And then just a question on the Cassis facility, the facility is shut down. Do you still have workers that you need to pay as part of your settlement?

Yes.

And is that all encompassed in the charges that you're taking in the first quarter?

Well, let me answer part of it, and then I will have Kevin make sure we get the restructuring pieces right. We still have approximately 20, I think 21 associates or employees that are being paid in the factory. There were a total of say 122, I think, there. So 101 of them basically are not -- are no longer on the payroll in part of the restructuring charge. But we've got 20-some that continue to be an operating expense for us in Cassis as we try to close this down. As you might imagine, there's still a lot of moving parts. We still have some legal wrangling that's going to go on with the -- certainly in the court systems with the one union that we are dealing with. But overall, we are for the first time I think seeing a pretty clear path. As you might imagine, what the ability to have a sale in place, that helps grease some of the political wheels to try and resolve some of these issues that continue to linger out there. Kevin, maybe if you can --

Just to add to that, our expectation would be that the restructuring expense that we talked about, $0.25 to $0.30, most of that would occur in the first quarter given for success of the ultimate shutdown, and most of that $18 to $22 million would be spent in the first quarter. Again, there'll be lingering costs that will kind of work out through the rest of the year.

But just to the point that you guys were raising is that a lot of people have been removed from that situation. You only have a few, and I assume that those costs themselves will continue to go down throughout the year?

Yes. Absolutely.

What happens is a large group of those people once we terminated production become part of the restructuring costs because they start drawing their severance payment.

Okay. And then just one more question, if I could, just on the operating expense side. Kevin, I thought last quarter that you might have said the operating expenses would be flattish. They were up maybe $4 million. Can you talk a little bit about how much of that was due to the revenue being relatively healthy, and how much of that is maybe due to some of the continued restructuring inefficiencies that you face?

I think a lot of what you saw in the fourth quarter versus third quarter OP expense increase had to do with the increased revenue. A portion of that, obviously, is variable relative to revenue volume. What I was speaking to when I said "flat", I think that we've reached near a run rate that we're going to be living with for the next year or two, relative to the increase spend that we've had to do on the IT area and other areas like that. And my expectation is that we are near a run rate now that reflects that in that plus or minus a couple million dollars in that front. But that was the thrust of what I meant there.

Okay. Great. Thank you much.

Sure.

And we'll take our next question from Gil Luria, Wedbush Morgan.

Hi, good morning.

Good morning.

I wanted to ask you a little bit about the progress you are making in terms of your cost cutting goals. Looks like you were able to eliminate 12, in those 6 -- $12 million, and an additional 23 identified in '07, which will put you on track to the $35 million of cost reductions for '07 that was part of your goal together with 65 in '08. Now having said that, if you are on track, it seems like stating that the 11% to 12% operating margin goal is in '09, is that a little bit of a pushout? My impression was that that was your goal in '08, or at least exiting '08 at that operating margin level.

Yes. I think -- let me answer the first part, in terms of the $35 million, I feel very confident in terms of us being able to get that out. We have very detailed systems in place, and we're monitoring that all the way down to individual projects led by individual engineers of how to get that. I feel good in terms of the process we have in place, the methodology, the tools, and we invested an awful lot of that in the first half of this year to really positioned ourselves to do that, and I have confidence in our ability to achieve that. In terms of the question, in terms of the 11% to 12%, what we're talking about there, that's the full year. While we would come out of maybe the end of '08 at that level for the quarter, we are talking about the full year being at 11% to 12%, and that's consistent with our previous communication.

In terms of the ERP implementation, is that also on track? You had to do -- you hired a new person. You had to review those plans. So that -- is that pushed out a little bit? Because again, the statement previously I think was that you'd have it all installed by the end of '08, and now you're saying end of '08 or beginning of '09. Is that substantial pushout or just being a little bit more careful?

This is Kevin. I don't think it's a substantial pushout, but it does reflect, we talked about in the fourth quarter, really doing a deep dive and reassessing everything, and we did that relative to the new talent we brought in, plus the new partners we were looking at and consultants, and we really kind of reassessed that to get ourselves at a confidence level of how to deployed this. And obviously, our expectation as we deployed beyond, to meet the other geographies, is that we're going to do it in a fashion that doesn't replicate the difficulty we had this year, this past year with EMEA. So a lot of thought's been given to that. It's still not positively complete. But it's getting near complete relative to that. And I think that's why we are talking about end of 2008, possibly beginning 2009, before we had it fully done.

Great. Then just one clarification. The bulk check imaging module prototype in November, will that be ready in time for some of those rollouts in the second half of 07'? Or are you not certain about when that rollout is?

No. We are very focussed on that. And that will be ready for the second half rollouts in 2007.

That's great. Thank you very much.

You're welcome.

And our next question comes from L.N. Ganti, Thomas Weisel Partners.

Hi, everybody. If you could talk about the gross margin targets. I know you have made sequential improvements there, but going forward, what do you think would be reasonable to achieve or when will you be [inaudible]. Maybe you could talk about that business or something like that.

Well, one way I would characterize it is relative to our commitment of getting 11% to 12% OP margin by the end of 2008, we we'd be looking for 3% to 3.5% of that improvement coming in the GP lines. So gross profit improvement. We'dl be looking at a 1% to 1.5% improvement relative to our OP spend, so that would render the 4% to 5% improvement required from our current levels to get up to what we need to get to 11% to 12%. Ask to give flavor within that, my expectation within product gross margins would be we would be looking at something between 3 to -- 2.5 to 3, 3.5, and then maybe 2 to 2.5 as we look at our service margins.

Points of improvement.

Of improvement. I'm sorry.

Okay. And this one is for Tom. You talked about -- apart from restructuring initiatives, you will be focusing on some of the other initiatives for 2007. Can you just lay that out for us?

I'm sorry, can you say that again? I'm not sure I caught the first part of that question.

Apart from your ongoing restructuring initiative, you also talked in the opening address that you will be focusing on a couple new initiatives like new product development and things like that. If you could outline what your priorities for 2007 would be, apart from your ongoing restructuring initiatives.

Sure. I think what we are referring to is some of the comments I've made to some previous questions. First, around deposit automation. The deposit automation solutions set is evolving as we speak. We have different components there. So the questions about bulk check, bringing that to market very quickly is a new product in the market for us that we think will be very effective and well received. The reason we have confidence in that is that we have been developing our own check imaging module for the past 15 years, but it was a single check module, which is what is used in the marketplace today. There is a requirement to have bulk checks, some of the bigger institutions want to have that. We have been working hard to take our single check to turn it into a bulk check device, and we think that is a very important strategic component in the marketplace. Again, we have in unique positions to be able to bring that.

The other thing I would mention, or reiterate, is focusing on the software side of things. We made some comments before that we think we can improve really our offerings in the EMEA region and help us there and take some additional work on the software front. I think the other thing is what we call almost outsourcing or integrated services. We have a very good business model in Brazil that we where able to get adopted by a major institution in Canada. We have seen some other institutions, smaller institutions in the U.S., other parts of Europe, beginning to have an interest in that. And I want to have a full offering there with the right competencies from an integrative services front.

On the self-service side of things, those would be the major aspects of what we are talking about. On the security side, it's the continued globalization of the business and it's continued focus on this government, high-end commercial, and retail space. And high-end commercial, just so you understand, would be we've got a lot of multinationals like a Microsoft or Intel that build facilities all around the world. They need security solutions. And if we provide it for them here, I want to be able to leverage our infrastructure in China to be able to provide it there as well. That's a big opportunity we were focussed on, on the security side.

Thanks a lot.

Okay.

And we'll take a follow-up question from Matt Summerville, KeyBanc.

What was your spend on your ERP system in 06' versus '05 that was not put in some sort of charge that everyone's excluding, and you are expecting that spend to accelerate further in '07? I guess I'm trying to understand whether or not we have seen the peak expenditures associated with them.

We had roughly incremental spend we just absorbed, which was about $7 million in 2006. And that was really things that we absorbed in the final seven months of the year. Our expectation is that would be fully analyzed in 2007, so we will be looking at incremental spend of $13 million versus 2005, if you will.

No. Incremental spend will be $5 million.

So I'm saying relative to '05.

Okay.

And to that point, in addition, we will have to absorb higher depreciation expense, which is going to be roughly another incremental $4 to $5 million.

But, Matt, I think the other part of that is we do think we have hit -- we are at the point where we think that's the run rate going forward. So we're not going to see anything above that, but that's what we've baked into our plan.

Okay. It got a little -- I couldn't hear part of the answer to the question. The incremental '07 versus '06, again, was $4 million, or $6 million?

$6 million of incremental spend. And then from a depreciation amortization standpoint, we're going to pick up another $4 million of incremental depreciation expense relative to this depreciating the asset.

Then, Tom, maybe you can just characterize the level of contingency that you've built into your guidance, and I guess what has to happen for you get upside.

I think from the potential upside standpoint would be we talked about the deposit automation, for instance, in the U.S. being a second half of the year kind of activity. As you know, with any of these major institutions that have 5,000 or 7,000 units, if someone decided to move that up by a quarter or something, that has tremendous impact in terms of our run rate. I would say another potential upside, as we think about it, would be if something happened in eastern Europe where you saw some accelerated growth out of Russia or the Ukraine, above kind of the ongoing run rate. I would see that as a potential upside. On the security front, again, now that we feel that we are much better equipped this year to deal with some major government contracts, and we can get on some GSA schedules, there is a possibility that something might happen in that space. So I would say those will probably be the three biggest areas of potential upside for us in 2007, not necessarily in the plan.

And then how much contingency have you built into your forecast?

I think -- I don't know if we have an exact number. But I would say that the guidance we've given I think is a fair representation of, given the market conditions and the growth rates we were looking at and our expense structure, we're pretty comfortable with that.

Okay, thank you.

You're welcome.

And we'lll take our final question from Manish Vora, Monness.

A quick question on the security business especially with the government business. Do you see the opportunity more of the ramp of the government business to be in 2008?

Yes. I think what I view 2007 as is really us kind of creating a reputation and being able to do some projects in that space. I think that will give us real credibility going forward. We also invested last year in some additional resources in, for instance, Washington, D.C., to be near where the contracts are let, as well as having people that understand how to respond to these. I see 2007, again, as kind of a learning year in the government space positioning us well for 2008 and beyond.

Can you comment a little bit on western Europe and deposit automation and what you are seeing there and how your position is up in that opportunity?

Okay. I would say the difference between western Europe and the United States, for instance, is deposit automation, you don't have the volume of checks you deal with in western Europe that you do in the United States. So deposit automation there has more to do with bulk note acceptance versus check handling, which is such a big requirement here. A lot of times they go hand in hand. Interestingly enough, one of the biggest markets we have is not in western Europe. It's in Russia. Russia ends up dealing a lot with deposit automation from a bulk note standpoint as almost a currency exchange type of device. But again, it's a different type of unit, a different type of selling motion that is in the United States when you talk about handling checks and handling cash. So that's my perspective relative to Europe.

Okay. Thank you.

You're welcome.

And Mr. Kristoff, at this time, I would like to turn the conference back to you for additional or closing remarks.

Thanks, Bill. Thank you to everyone for joining us today. Before we go, I would just like to mention our upcoming investment community conference for 2007, will actual be held on May 16th and 17th at our headquarters in Ohio. You want to hold those dates if you are planning on coming, and we will make more details available in the coming months as we put that conference together. As always, if you have follow-up questions, please feel free to call me directly. Thank you again.

Again, that does conclude today's conference call. We do thank you for your participation. You may disconnect at this time.