Diebold Nixdorf Inc (DBD) 2009 Q3 法說會逐字稿

Good day, everyone. Welcome to Diebold Incorporated's third quarter financial results conference call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to the Vice President and Chief Communications Officer, Mr. Kristoff. Please go ahead.

Thank you, Jessica. Good morning, everyone. Thank you for joining us for Diebold's third quarter conference call. Joining me today are Tom Swidarski, President and Chief Executive Officer; and Leslie Pierce, our Corporate Controller and interim Chief Financial Officer.

Just a few notes before we get started. In addition to the earnings release, we've provided a supplementary presentation on the Investor page of our website. Tom and Leslie will be walking through this presentation as part of their opening comments this morning and we encourage you to follow along. We've included non-GAAP financial measures throughout our presentation this morning. Specifically, I refer you to Slides 27 through 37, which provide our rationale for the use of non-GAAP measures as well as GAAP to non-GAAP reconciliations. A replay of this conference call will be available later today from our website.

As a reminder, some of the comments today may be considered forward-looking statements. Internal and/or external factors could significantly impact actual results and as a precaution, we refer you to the more detailed risk factors that have previously been filed with the FCC. Now for opening remarks, I'll turn it over to Tom.

Thanks, John. Good morning, everyone. Like many of our peers in the financial self-service and security industry, we continue to experience headwinds in our core markets. Similar to our peers, we had setbacks in both order entry and revenue in the third quarter. It's important to note that we face very difficult comparisons to the third quarter of 2008, which represented the highest quarterly earnings per share in the company's history. In spite of that, we still performed very successfully in other areas. I'm encouraged by the progress we've made on various key business improvement initiatives under our direct control, such as working capital management, which has resulted in significant increase in our free cash flow.

Since our last call, we executed on a number of key strategic priorities for the company. As we announced yesterday, we feel very fortunate to have added Brad Richardson, our new CFO, to our management team. Brad's diverse experience and expertise in working capital management, international business operations, and sound financial reporting practices will be invaluable for Diebold moving forward. More importantly, Brad's experience in transforming an organization, its processes and infrastructure in a very rapidly changing market environment, is relevant to our current needs. He has a collaborative style that I feel will resonate with our leadership team, associates, shareholders, and customers. Brad will begin his new role later this month and we look forward to having him participate in our year end earnings call.

On September 2, we finalized the sale of Premier Election Solutions, our US election systems business. Early in 2006, we identified this business as non-core to our company and had been pursuing opportunities to divest it since that time. Similar to our decision to close our manufacturing facility in France, this divestiture process was long and extremely challenging. Regardless of these challenges, exiting the US elections business was the right strategic decision and represents our resolve in making difficult decisions that better position the company for long-term success.

From an operational perspective, we continue to make progress in lowering our overall cost structure. We remain on track to achieve our $35 million in cost savings by the end of the year as part of our SmartBusiness 200 cost reduction initiative. We also continue to slightly reduce operating expenses on a dollar basis while maintaining our investment in future product and services solutions. This strategy will help strengthen our competitive position when our core markets return to growth.

We generated our ninth consecutive quarter of year-over-year improved service gross margin. We also continue to make progress on improving our working capital, which has resulted in a year-to-date free cash flow improvement of more than $65 million and we improved our net debt position. Also, we finalized our credit facility renewal, which was due to expire in April 2010. Our strong balance sheet and liquidity continues to be particularly important asset, especially in light of the current environment. So from a management perspective, I'm pleased with the progress we continue to make on the various business improvement initiatives under our direct control.

Now, turning to an overview of our end markets, while we performed well in the third quarter considering the environment we're facing, customer spending remains very restrained in our core financial markets. Overall, we still believe our markets reached their low point earlier this year. While we have not seen any rebound in demand, in most markets we've seen further signs of stability.

Looking at financial self service performance during the first quarter, let's first turn to the Americas. As in the first half of the year, the largest banks in the United States continued their scheduled deployment of deposit automation technology. While there will be additional deposit automation opportunity within the large bank segment in 2010, we don't expect to repeat the product revenue levels we generated in the space in 2009. However, we are seeing new deposit automation opportunities in Latin American countries such as Mexico and Colombia in 2010.

In regards to the United States regional bank segment, deposit automation deployment activity remained weak, which is in line with our expectations. As we indicated on the previous call, we are seeing more activity in terms of RFP and general customer interest. And while we continue to view this as an encouraging development, the sales cycle seems to be lengthening somewhat, and we have not yet seen a sustained pickup in our order book. On a macro level, there has been no significant improvement in the US regional bank segment. The FDIC recently voted unanimously to propose a plan that would require banks to prepay on December 30, 2009 assessments for the fourth quarter of 2009, and for 2010, 2011 and 2012. The FDIC assessment estimates that the assessments would raise about $45 billion.

While these fees will be expensed over the three-year period, the cash prepayment may significantly reduce the capital available for technology investments by those institutions. As a result, we perceive continued weak demand in the regional bank segment for at least the next several months. However, the limited capital spending available in this environment creates further opportunity to grow our integrated services or outsourcing business across all the Americas. Brazil's been the world leader in outsourcing for the past 10 years, and we are applying those best practices in Colombia, Mexico and Canada, in addition to the United States. By turning over the ATM network and security operation elements of their business to us, financial institutions avoid additional capital spend on new equipment and are able to focus on their core competency of providing financial services to consumers. This solution is continuing to resonate with customers worldwide, as we turned in another solid growth quarter in this segment.

Through the first three quarters of the year, we have added more than 1,000 new sites to our integrated services portfolio. In terms of total contract value, the business has grown more than 15% from the first three quarters of last year. Bear in mind the sales cycle in this space is longer than what we historically have seen in our traditional business, given the fact that the customer's taking on a different business model than just purchasing a piece of hardware or an individual managed service. Our customer sees value in having a single point of contact and full visibility to spend and cost savings and manage their self service networks. This is why our integrated services portfolio is highly relevant in a marketplace that's struggling to manage capital. Lastly, in Latin America, third quarter revenue is down due to timing of installation, particularly in Brazil. However, for the full year, we still anticipate repeating the strong performance we had in 2008 in Brazil and the rest of the region.

Now, turning to EMEA, the financial self service market in Western Europe weakened further during the third quarter. This resulted in a significant drop in both revenue and orders. However, we are encouraged by very strong order entry in Europe for the month of October. In fact, product order entry in October alone exceeded any full quarter of order entry we've seen all year in this region. As a result, we don't view the third quarter weakness as any indication of a real shift in demand. In eastern Europe, our outlook has not changed as we continue to experience low levels of order activity.

Asia-Pacific revenue for the quarter was in line with our expectations. As I mentioned during the previous call, ATM deployment in China is even more front end loaded than in 2008. This creates difficult revenue comparisons for the Asia-Pacific region during the latter quarters of the year. However, overall demand in the region remains strong, and we expect to achieve full year revenue in this region similar to 2008, which represented our strongest year ever in the region.

To summarize the financial self-service business, demand has continued to stabilize, albeit at lower overall levels. This has resulted in some increased price competition, particularly among the largest deals, as overcapacity may have motivated some of our competitors to lower prices in an attempt to drive more volume through their manufacturing plants. Our approach is different. We made a commitment in 2006 to be disciplined on pricing and we remain steadfast in that commitment.

As you are aware, we've also worked hard to redistribute and reduce our manufacturing capacity to be more aligned with current demand. Most recently in September, we announced that we are ending all remaining Opteva ATM manufacturing in our Lexington, North Carolina facility. This will drive more volume and improve utilization through our Budapest and Shanghai facilities. These efforts, as well as our continued competitive advantage on services, have positioned us not to have to compromise our pricing philosophy for the sake of increased volume. As a result of this strategy, we believe we can continue to capture a fair share of the market while maintaining pricing discipline and protecting margins.

Now, looking at our security business, we've seen little to no change in the market environment from what we communicated to you during the last call. New branch construction and facility renovations remain at about half of recent levels, as the US regional bank space continues to experience depressed capital spending levels. Our perspective on the retail government and commercial security markets also remain the same through the second quarter. Capital spending in the retail segment remains tight, while we've seen a slight pickup in opportunities in the commercial space. In the government market, we see a lot of opportunity, but we've seen some pushouts of major projects into 2010. Sequentially, however, we did see some stabilization in the market from the second quarter, as orders and revenue both saw modest increases for the first time in three quarters. While it's too early to say we've begun to turn a corner in terms of recovery in our security business, I'm encouraged by the slight signs of growth from the second quarter.

Looking at our operations, we continue to make progress on a number of initiatives. As I previously mentioned, our SmartBusiness 200 cost reduction initiative remains on track to achieve our savings target of $35 million in 2009. We also continue to make progress in working capital management, as demonstrated by our significant improvement in net debt and year to date free cash flow. Because of the economic environment we're operating in, it's never been more critical to successfully manage elements of our business that are within our control. Based on the progress we've made to date, I'm confident we'll continue to crisply execute on these elements of our plan that have a critical bearing on our performance going forward.

In summary, our overall outlook for the year remains essentially unchanged. We continue to face a challenging market environment, and are taking the appropriate steps to be successful and position ourselves for future growth. Once again, we have tightened our earnings guidance as we've gained additional clarity on the business environment as the year has progressed. However, guidance is still within the range that we provided during our first quarter earnings call. This is an indication that the market stabilization we foresaw earlier in the year has largely played out as expected.

As we look to 2010, while we're not in a position to provide specific financial guidance today, there are a number of considerations I would like to share. First, we expect to achieve moderate levels of top line growth next year, driven primarily by slight growth in the financial self service business, with expected addition of the Brazilian election systems revenue. Many of you have asked me to quantify our expectations for the Brazilian elections revenue in 2010. It's very difficult to quantify the opportunity because of the way the contract is structured. The bid is to deliver at least 80,000 voting terminals over the next two years. In addition, there's at least one strong competitor vying for the bid. By contrast, in 2008, we were the sole bidder and delivered approximately 60,000 terminals, nearly all in the third quarter of that year. The Brazilian government has indicated that this is a winner-take-all bid and the contract is expected to be awarded in the first quarter.

Another consideration for 2010 is increased interest in pension expense. I mentioned earlier we recently renewed our credit facility. While we secured a very favorable rate, market rates have increased considerably since our last facility was renewed. As a result, we expect interest expense to increase by approximately $7 million to $9 million in 2010. On a pension front, we anticipate expense to increase modestly by approximately $4 million to $9 million as it stands today. As you may recall, like many companies during the recent financial downturn in 2009, we suspended our 401(k) match and froze salaries at current levels. It is our intent, as business conditions allow, to reinstate a 401(k) match, as well as modest salary increases in 2010. This is also an important consideration as we look to next year.

Looking forward, as we continue to move our company to an increased focus on services, we will manage our business as we have during the course of the financial downturn by striking an appropriate balance between reducing costs and investing in our future growth. We will continue to position our operations and cost structure so the realities of the marketplace. We will continue to differentiate ourselves on our total value proposition, particularly as it relates to services, and we will maintain pricing discipline. While we remain cautious in our outlook, we are optimistic that 2010 will bring opportunities for growth and modest recovery in our core financial markets.

Now, before I turn the call over to Leslie Pierce, I would like to take this opportunity to personally thank her and the entire finance team and recognize their efforts during the entire year. By serving as our interim CFO, Leslie performed admirably in providing continuity in managing our financial control processes, supporting our communications to the Street, and being the lead steward in strengthening our company's discipline in this regard. As our corporate controller, she will continue to play an invaluable role for us by leading mediation efforts and maintaining our tight financial management approach as we move into 2010. Thanks for your contributions, Leslie. And with that, I'll turn the call over to you.

Thanks, Tom, and good morning, everyone. Before we discuss our third quarter financial results, as with past calls, it's important to note that we have restructuring charges, nonroutine income and expense, as well as impairment charges in our financial results. We believe that excluding these items gives an indication of the company's baseline performance. As a result, many of my remarks will focus on non-GAAP financial information. For a reconciliation of our GAAP to non-GAAP numbers, please refer to Slides 27 to 37 in the supplemental material provided on our website. In addition, all results of operations reported today, including prior periods, reflect Premier Election Solutions as a discontinued operation.

Now let's turn to our financial results. First, I would like to refer to Slide 14, which focuses on the third quarter revenue. Total revenue decreased $224 million or 26% in the third quarter, which included a net negative currency impact of 2%. Product revenue was down 40%, and service revenue was down 10%. About two-thirds of the decrease in product revenue is largely due to lower demand across all of our core markets, with the remainder of the decrease due to the Brazilian elections revenue not repeating in the third quarter this year. The drop in service revenue was mainly attributable to the insourcing of a large Brazilian government contract we discussed during the previous call, as well as lower installation volume.

Looking at our financial self service business on Slide 15, revenue decreased $130 million or 21% in the third quarter. This decrease was attributable to lower demand across all geographies, with EMEA especially effected.

Now turning to Slide 16, our third quarter security revenue decreased $37 million or 19%. Security revenue continues to be adversely effected by significant weakness in the US financial market, mainly in the regional bank segment. While spending remains weak, as Tom mentioned, we did see sequential improvement in the business from the second quarter.

Turning next to non-GAAP total gross margin, refer to Slide 17. In the third quarter 2009, gross margin was 23.8%, down from 27.5% in Q3 2008. Product gross margin in Q3 2009 declined 8.1 percentage points compared with a strong third quarter in 2008. The decrease was due primarily to a significant decrease in overall revenue, including a $58 million decline in Brazilian elections equipment from the third quarter in 2008. The Brazilian elections revenue generated gross margins significantly higher than the company's average, largely as a result of significant strengthening of the Brazilian real against the US dollar between the time we booked the order and manufactured the equipment in 2008. Conversely, service gross margin in the third quarter 2009 improved by 0.5 percentage points to 25.4%. This improvement came as a result of continued productivity gains and favorable year-over-year fuel costs.

Moving now to non-GAAP operating expense, as highlighted on Slide 18, in Q3 2009, operating expense as a percentage of revenue was 18.7% compared with 15.4% in the comparable period of 2008. On a dollar basis, however, operating expense decreased more than $13 million compared with the third quarter 2008. Operating expense is down across all geographies as we continue to focus on managing costs. It's important to note that despite the drop in revenue, we are maintaining our current levels of investment in R&D and our IT infrastructure.

Now, if you would turn to Slide 19, non-GAAP operating profit margin in the third quarter 2009 was 5.1% compared to 12.1% in the third quarter 2008. This decrease was due to the decline in product gross margins noted earlier, as well as negative leveraging of operating expenses on declining revenue. On a year to date basis, operating profit as a percentage of net sales was 6.1% compared to 9.1% for 2008. Our third quarter tax rate of 14.1% for non-GAAP continuing operations includes a year-to-date adjustment to address the higher percentage of income coming from lower tax regions, such as Brazil and Asia-Pacific. We anticipate the full year tax rate will be approximately 18%.

Turning to the EPS reconciliation on Slide 20, non-GAAP EPS from continuing operations in the third quarter was $0.39 compared with $1.18 in the third quarter of 2008. Again, third quarter 2008 earnings were by far the highest quarterly earnings in the company's history. Therefore, we were working against a very difficult comparison in the third quarter.

Turning next to free cash flow on Slide 21, I was pleased with our free cash flow performance the first nine months of 2009, which we define as net cash from operating activities less capital expenditures. Free cash flow in the third quarter was $37 million. For the first nine months of 2009, free cash flow was $94 million, an increase of $65 million from the comparable nine-month figures in 2008. This improvement was mainly attributable to the progress we've made in our working capital metrics, which we will cover on the next two slides.

On Slide 22, day sales outstanding or DSO improved by eight days, moving from 54 days at September 30, 2008 to 46 days at September 30, 2009. We view DSO as a leading indicator of performance and are pleased that we are able to continue to build upon the gains we have already made. On Slide 23, inventory turns improved from 4.1 turns at September 30, 2008 to 4.3 turns at September 30, 2009.

Turning next to liquidity and net debt on Slide 24, net debt at September 30, 2009 was $208 million, a decrease of about $170 million from September 30, 2008. Our net debt to capital ratio was 17% at September 30, 2009 compared to 25% at September 30, 2008. During these challenging economic times, we continue to exercise discipline in maintaining a strong balance sheet. Also, on our last call, we discussed our credit facility was due to expire next year, and we are pleased that on October 19, we had entered into a new $400 million and EUR75 million credit facility agreement with certain key relationship banks. The new arrangement maintains existing covenants that were already in place and is unsecured. The new credit facility is for a term of three years and expires in October 2012. The all-in interest rate spread increased to 275 basis points over LIBOR from our current rate of 50 basis points over LIBOR.

Turning to our full year outlook for 2009, as Tom mentioned in his remarks, we continued to experience a tough environment within our core financial markets. However, our guidance is still in the range we provided in the first quarter. Before I address specifics behind our guidance, let me spend a moment on Slide 25 to review the impact of the divestiture of our US election system business, Premier Election Solutions. It is reported as a discontinued operation and our guidance is always provided on a continuing operations basis. Removing Premier from our continuing operations has the following impact. Non-GAAP first quarter earnings per share from continuing operations is now $0.46, while second quarter EPS is now $0.51. This represents an increase of approximately $0.09 per share versus what was previously reported for the first half of the year. However, the previous forecast for Premier was a profit of approximately $0.04 per share for the second half of the year, which has been removed from our current guidance. Therefore, the full year net impact on current earnings per share guidance from continuing operations is a net increase of $0.05.

Turning to Slide 26 to our revised guidance for 2009, revenue expectations in total remain essentially unchanged, while we have tightened guidance in each of the business segments as we now have more clarity. We expect total revenue to decline 9% to 13%, with currency headwinds of about 2%. Financial self service revenue is now expected to decline 6% to 8%. We now expect security revenue to decline in the range of 14% to 17%. Lastly, with the sale of Premier and no planned activity in Brazil, we expect no elections revenue this year, and lottery systems revenue of $5 million to $7 million. We now expect our full year 2009 GAAP EPS to be in the range of $1.34 to $1.39. Excluding restructuring and nonroutine expenses in income, non-GAAP EPS is expected to be in the range of $1.75 to $1.80. This non-GAAP EPS guidance assumes a full year effective tax rate of approximately 18%.

We continue to make progress on addressing our remaining material weaknesses. Through the third quarter, we fully remediated three of the six material weaknesses that were identified as part of the restatement process. We have made significant progress on remediating the remaining three weaknesses and are on track to have all six remediated by the end of this year.

We are committed to improving our financial control systems, processes, and procedures, with proper controls that drive efficiency, accuracy, and timeliness in our accounting and financial reporting. I look forward to working with our new CFO, Brad Richardson, on completing all the work that has been planned on this front, as well as implementing additional ongoing improvement initiatives related to controls, working capital and cost management, and financial reporting.

Thank you for your time. Now I'll turn the call back to John.

Thanks, Leslie. Jessica, we would like to open the call up now for our first question.

(Operator Instructions). Our first question comes from Kartik Mehta with Northcoast Research.

Good morning, Tom. I just want to make sure I understood some of the statements you made about 2010. You had said you anticipate moderate growth. Would that have included any Brazilian election business you might get in 2010, or was that growth based on what the market is right now, and if you get the Brazilian business, that would change?

We're looking at that as modest growth including the Brazil election business, Kartik. So while we don't know exactly what the Brazilian piece is, we have confidence in our group in Brazil the way we've delivered that in the past and think that we're well positioned there, even though there's no guarantees. So our expectations -- we have modest growth and some of that is the Brazil piece. Depending upon the size of that, Brazil piece would influence our expectations on growth. So we still, as I mentioned there, don't have clarity the way the RFP is written today, and as I mentioned, the reward, the award will be in the first quarter of next year and it's a winner-take-all scenario. But the way it's worded, and we reviewed that, is at least 80,000 terminals over a two-year period.

So, again, depending on the assumptions that are made there, and we'll learn a lot more. Because I think we have to respond to the bid at the end of this month and we'll be actually doing that in person. We'll get a lot more insight there. So while we've seen a little bit more of stabilization in terms of the overall market, when you balance security and self service, you would say security basically flat, maybe a little moderate growth in self service, and hopefully something from the Brazilian elections the way I'm looking at it.

And Tom, just as a clarification, you said the last order was for 60,000 units and that was just in that one year, right? So this would be 80,000 over two years?

But the way it's worded is at least 80,000. So, again, not having had the opportunity of actually present this and have the dialogue, we're just going from the RFP, and we'll learn a lot more at the end of the month when we actually go in and submit the bid and have the face-to-face meetings.

Now, would you expect the margins for that business to be any different than they were last time? I know you said there is one other competitor in the marketplace. But I didn't know how the bids worked in Brazil, and so I didn't know if there was any chance of the margins being different or if we could look at the last -- to get a sense of what the impact could be to earnings.

No, there will be a significant difference between this time and last time. Last time we ended up in the bid process as a sole provider. This year, we know of at least one other significant player on a world scale that will be there. I think the second thing was last year there was a significant movement in terms of currency. So after we took the order, by the time we fulfilled it, currency had I think an impact of like 12% to 14% range, which happened to work in our favor, which, again, was just more fortuitous than it was actually having the ability to impact that. So I think those two factors alone would suggest that this would be materially different.

The other thing I would point to is the -- unlike the last bid in this case, they have specified a specific price point and they have also specified specific specs. By that I mean this time there's capabilities of biometrics. They also have a specific printer that we're looking into. So the functional requirements are much higher and the price point is lower. So I already know that the -- I would expect margins to be significantly less than last time. But I think from an overall standpoint, I'm still expecting they would be accretive compared to all the businesses we're in. But nowhere near where they were last time.

And then, Tom, you talked a little bit about just looking at 2010 what could hurt obviously pension expense, when we're looking at operating income. But as you look, you're going to obviously have cost savings this year, plan to have cost savings next year. Based on where the markets are, would you anticipate operating margins to continue improving next year, if the markets stay where they are?

Yes. I mean I would expect we improve operating margins next year, and I would expect that if we get the leverage from increased volumes to make a material impact in terms of the margins. But as it stands today, our outlook is not aggressive in that regard from the standpoint that the markets are still relatively weak. And orders take three to six months before they revenue, so even activity that's taking place today generally is going to revenue sometime in 2010 time period. But our expectation is going into 2010 to improve operating margins.

And one last question, Tom. You talked a little bit about the regional banks and community banks, and they are looking at deposit automation, but you're not seeing any spending. Do you anticipate that when the community banks do come back in the market, that all of a sudden you could see a big boost in spending? Or do you think when they come back, it'll be business as usual and we'll see some spending start, but it will be at a little bit slower pace?

Well, I think two things to that, Kartik. First, I think a lot of the reason, and maybe we haven't talked much about it before, maybe we did at the analyst day -- was the infrastructure needs to be there for the small regional community banks to move. The big banks control the core processing. They control the network processor. So with an ATM, it's connected to a processor and that's corrected to core system. And until all of those pieces are in place, the real benefits of what you get from deposit automation from a small guy is not necessarily realized. But what I'm seeing now is pretty solid plans for most of the processors and most of the networks of being able to handle deposit automation and handle it in a way that's not an emulation of depositing in an envelope, the emulation of being able to clear the check and handle the cash directly, which would be a big boost forward to the business case for a regional small community bank. I think, again, because there's so many processes out there and there's so many pieces of the infrastructure that need to be in place, I think this is a gradual movement. But I would say that next year, we see more activity in that regard, but really 2011 and 2012, I would say there would be significant pickup in that space in the US.

Thanks so much, Tom.

Okay, you're welcome.

Our next question comes from Matt Summerville with KeyBanc.

Couple questions. Good morning. First, Tom, can you give a little more detail as to what transpired in your order book in EMEA or what customers have been saying the last three to four months, why the third quarter was so bad and then all of a sudden you're seeing a pretty nice pickup here in October? And I guess then the follow-on to that would be how you feel about that sustainability?

Okay. Regarding EMEA, it's almost regarding all of the numbers. You have an activity that takes place in the quarter. Unfortunately, the customers don't really care about our quarter type of reporting results. They care about going through their processes and the diligence that they need to make a decision. So I take some comfort that October looks solid, but you look back in October and you look back in the third quarter and the second quarter -- you say, hey, it's weak, and you have to look over the course of the entire year to say how do we improve, how did we do overall? So the fourth quarter orders we took in October, many of those were in the very front end of the month. Thus we have visibility to that, which makes us feel better about things we are being promised from the market that actually came to fruition. They could have just as easily been a week earlier, and the third quarter might have looked a little bit different than it does. But as such, our fourth quarter comparisons are going look good as a result of timing.

The other thing I would point to there, the good news for me, it wasn't just one or two individual orders. It was from the Middle East. It was a little bit from South Africa, a little bit from Western Europe. And that to me was a good signal for the first time for us in the European marketplace to say that's -- there's some breadth there that makes you a little more comfortable than if it was just one significant order. So as I think about it, I think about it -- while I'm thrilled that this happened in October, I have -- I need to see this trend happen and see what the whole fourth quarter looks like and then look at it in comparison to the whole year, and it still will be a weak year no matter what we do in the fourth quarter, even though the fourth quarter should show a significant pickup compared to last year, EMEA specifically.

Can you give a little more color around what your small bank customers in the US are saying right now about their capital deployment plans in 2010 in light of everything that's impacting that specific customer base? In terms of both their propensity to buy new ATMs versus go that integrated services model. And I guess where are you with the sales cycle in that regard?

Okay. I think overall, I would say that the trend continues that the lengthening of the sales cycle is evident. And it's either simply because the regional banks are hesitant or there's always a cloud that we thought was going to pass relative to the FDIC assessment that's back on the horizon or all the other issues that they are facing. It seems like people remain hesitant. Now, in that hesitation, it's given us a real opportunity from the integrated services standpoint and specifically within the regional banks in the US. We've -- as I alluded to on my opening comments, we've had more activity in terms of RFPs and responses, and we've had symposiums across the United States where we've gotten a lot of momentum in that regard, and we've seen a lot of that turn into some activity here in 2009. But the way that those are booked, that's a five-year contract -- which is good, but you only recognize certain parts of the revenue here in 2009.

So I would say I like that for our future ability to be able to deliver solutions and it seems like the message is being received well. But because these decisions end up being five-year contracts, they're much broader decisions than buying a piece of equipment or one piece of integrated services versus the holistic approach, and as such, it takes time to get through the process and you pitch it at the very highest levels of the bank.

So in that regard, I'm confident in terms of our ability to deliver integrated services and I think that we've seen continued weakness relative to the regional bank space just in general. It's affected the security business more than it has self service, so when you look at our guidance in terms of, from a revenue guidance standpoint, you see where security is down double digits. We see self service down single digits. And when you look at that year-over-year in comparison to our peers, we think we're in pretty good shape in that regard. But for the regional guys specifically in the US, I still see continued caution out there and I see that for the next several months.

With regards to the security business, a couple of questions there. First, how much in terms of revenue do you think contractually that you have -- I think you called out government -- do you believe has been pushed from 2009 to 2010? That's the first question. And then the second question, in your -- I forget what slide it was on, 12 or 13, your comments regarding your viewpoint for 2010, do you see the security business growing? Do you see another big leg down? And involved in that, in your thought process there, how do you view new branch construction?

Okay. I will try and answer all of those, Matt, and if I miss one piece, please come back to it. But in terms of 2010, I see security having bottomed out and being basically flat. I'm not optimistic to say that there's going to be huge rebound next year. I don't see that happening, given the branch growth or the lack of branch growth and lack of renovation, and because the financial sector is so big for us, the fact that -- it's going to be the big driver. If that would increase 5% or 10%, it would be a whole different picture there in the security space, but it's not. It's relatively flat and physical security will be down. Electronic security will be up. When you mix that together, that looks like a very flat picture.

I would expect government and commercial pieces to grow for us next year. But they are not big enough pieces to have the overall impact that I would like them to have long-term. But I see some opportunities there, and several of those would be major opportunities that, again, like the post office, would be multiyear contracts. We would be building a nice infrastructure or base model for those businesses long-term. Retail, we continue to see it being very tight, and we've seen a lot of hesitation there and we've seen some retailers closing facilities that have an impact on us. So when I mix all of that together, I come to a very flat scenario for security business in 2010.

Thanks a lot, Tom.

You're welcome.

Our next question comes from Gil Luria with Wedbush.

Yes, good morning. You've mentioned a little bit of the national banks in the US. To the best of my understanding, Banc of America is going to be done rolling out its deposit automation ATMs this year and obviously they are big part of that national bank picture with Chase and Wells. Should we expect that one-third of that business is going to drop off next year since only Wells and Chase will continue, Banc of America is going to drop off, just within national banks in the US, those large banks?

Gil, let me answer it this way, because I don't know individually -- be able to comment on each of the banks, but we look at the whole group of them. We have what we would call 15 major players. Certainly the top three players who have deployed quite a bit would see a drop-off and in some cases maybe a market dropoff, but we have other players just coming into the very beginning stages of the deployment. When you mix those pieces together, I wouldn't say we would be down some 30%. I would say we would be down either teens to maybe 20% level for just that group in and of itself.

Got it. And then your order, as you characterized it in the press release on a year-over-year basis, can you tell us by the major geographies what your orders look like Q3 compared to Q2?

Let me see here. When I look at orders relative to Q2, I would say that by and large we were down slightly Q2 to Q3. Some of that has to do just simply with timing of the way certain things happen. As we mentioned, I think China ends up moving, we ended up moving some of China into the second quarter that was originally scheduled in the first quarter both from a revenue and an order standpoint. Overall, when you look at it, you would say we're down sequentially from Q2, and then our expectation is Q4, we would be in the other direction, that we would be up relative to Q3 on a significant basis from an order entry standpoint. And certainly Europe getting out of the gate the way it did in October is a good boost in that regard, and we'll get a lot more visibility as we go through that.

But again, I'm expecting that the US remains about the same way it has been. It's not been very robust, but as we compare now to the fourth quarter of last year, the fourth quarter of last year is when we first started to see the major impact of the financial downturn from our standpoint. So the comps become a little bit more favorable in that regard, whereas for up through quarter three of this year, our comps were very difficult because we had a very, very strong first three quarters of order entry and revenue last year.

Got it. In terms of your -- the Brazil election business, could you characterize for us the competitor there? Is this a large corporation that maybe makes ATMs? Is this just a small upstart? Is this somebody formidable?

Yes, this is a formidable foe that's not in the ATM space, but in I would call the securities space and the election space worldwide. So this is someone that has done other countries and has now turned their sights relative to Brazil, and we consider it a very formidable foe and with the resources to do supply chain, with the resources to deal with significant outsource manufacturing and have the competency to do that. So I think -- that's the one that I'm certainly aware of. There may be other players in that region that show up, but I'm not sure anyone else really is going to have the technical capability to meet the specs that we're seeing coming out of this.

Got it. Then a couple of financial clarifications. So in terms of the change in guidance, it went from $1.70 to $1.90 that included US elections to $1.75 to $1.80 that does not include US elections and got $0.05 benefit from the exclusion of US elections, is that right?

That is absolutely correct.

Then one last thing, 2010 tax rate, can you at least give us a range of where we should expect that, given tax rate has been a little unpredictable?

I think we're talking -- I'm looking at Leslie here, make sure if I'm incorrect, you'll correct me. But I think we're talking about the mid-20s for next year, 2010.

Yes, low to mid-20s.

Okay.

Great, thank you.

Our next question comes from Reik Read with Robert Baird and Company.

Hey, good morning. Just a follow-up on the Brazilian elections business. I mean you're suggesting that that's in your guidance, which suggests that you feel you've got pretty good position there, Tom. Can you talk a little bit about why you feel you have that position against what you're talking about as a formidable foe?

Sure. Let me be clear, Reik. We really haven't given any guidance for 2010. I think what I was trying to do is frame up some of the big pieces of 2010 in terms of headwinds and other things to consider as we frame up 2010 guidance, but I'll give you my perspective as to the landscape, and this is such a significant opportunity that had such an impact on 2008 that I thought it was worthy of talking about for 2010, unlike maybe just other regular opportunities. This is size and importance.

The reason I feel good about our positioning there is two-fold. Number one, over the past three election cycles that they have had in Brazil, we have been a significant supplier. They have used another entity in one of the elections, but I think our performance allowed us to get the entire business from the last time they did this in 2008. Second, the requirements that they have for the turnaround time means that you need to have the capability of both project management and the manufacturing capacity, as well as the ability to integrate to be able to do that in a pretty nimble fashion. So while you can contract out the manufacturing, at some point you got to have the capabilities and resources to actually do the integration. And we have both the manufacturing and the integration capabilities sitting right there in Brazil that we do every day on the self-service side and have done this for the Brazilian government as well.

I would say the third point is, the engineering specs for this, it's not just taking 2008 and doing the same terminal again. They add new levels of security for this. They've added as I mentioned before a biometric interface here. They also have the need for some type of printing capabilities and a couple other nuances that make the skillset required to be able to do this, to integrate the software and hardware, a high level integration. And so for that, it would take a very serious capable organization to do that, and there's another one that I think is going to be at the table from what we've heard.

But we are confident that since we've been able to do that and deliver it before, and because of the importance of the election, we've got some confidence that folks have worked with us before. They know what we can deliver, and we think in that regard we're positioned pretty well for this opportunity. And again, as I indicated, we'll know a whole lot more by the end of this month and they are going to be awarding this in the first quarter, so it will come to light very soon.

And does that other player have both integration and manufacturing capability like you?

No, I think they -- I would say they have integration capabilities, not necessarily manufacturing.

Okay, and then just going back to the integrated services business, it seems like you're having a pretty good ramp in terms of number of people that are starting to move towards that. Can you talk a little bit about how quickly you're actually adding new customers and what the level of service offering uptake is as you're putting those folks online?

Yes, and I don't have specific numbers that I can point to, other than the broad one to say we've added about 1,000 over the course of this year. And that's 1,000, not institutions, but 1,000 devices. Generally what happens with these contracts is people may give you 50 or 100 and you end up moving them on to your system over the course of three to six months. And then from that integration process, then they have a host of services that they are selecting.

So the opportunity here is not only you get a sticky relationship, but then to be able to upsell. And as we've seen, as we've seen to date we've had pretty good success when we have someone on for a 12 to 14 month period to be able to sell them a third or fourth service. Not everyone takes every one of those services coming out of the gate, but as you start taking over other operations and they are looking at your reporting and your controls and the audit process, they get a little more comfortable with it. So we'll feel good about that.

I think we've added about 20%, somewhere in that range, to the base compared to last year. So we're good -- we feel good in terms of the ability to sell it. We feel good in terms of our ability to deliver it and have a value there, and for us we think is a big value proposition in a competitive opportunity that we're going to drive very hard in the future. And this is not just something we're doing in the Americas, although in the Americas we have better infrastructure to be able to do it, but we have a bank in China. We've got banks in India. We've got banks in the European union. So those are just smaller operations than we have in the Americas.

And outside of Brazil, which I know has always been a larger region for these type of offerings, how quickly does it become really material? Is it -- does it happen in 2010 or just because of the longer cycle here, it's more of a 2011 and beyond story?

No, I think the real impact is down the road in terms of as you get -- you're building on those revenues. The real revenue is down the road. But the opportunities are right now. I mean we've got several in Colombia that we're working on, and I could go through each of the Latin American countries and Mexico, and I think we've got some real viable opportunities right in front of us to expand this outside of Brazil, outside the US, outside of Canada, in a meaningful way. Although I don't think it will have a material impact on the revenue that they experience next year, it will down the road.

Okay, and one last question on the pricing front. You mentioned that you guys are maintaining discipline. Does that mean today that you're having to walk away from business, or has the actions that you've taken in shutting down some facilities allow you to deal with those price exceptions more directly? Or does that take some time still?

Well, I think a couple things. One, relative to pricing, there are -- I mean it is impactful in terms of the real significant opportunities, whether it be self service or on the security side. I mean you find yourself in those discussions. We analyze them on a case by case basis. We have a process where they bubble up. We get visibility to them. But I would say yes, there have been occasions where we walked away where we don't think the pricing made sense. And for us it's not a matter of you lose an opportunity. It's a matter of what the impact is on your existing base and the existing relationships that you have, and honoring those appropriately.

I think we continue to feel that we've been in a very good competitive position. When we look at our revenue for self service, I mean if you compare that to the competitors across the globe, while our revenue for the year, our guidance is down 6% to 8% -- when you compare that to others, we feel we've more than held our own there. So we think that our behavior has been the appropriate behavior. We evaluate it every time, because you imagine there's a country or there's a service manager or sales manager who wants to win every deal. But for us, it's a matter of having the discipline in place and we feel good about what we're doing.

Okay, great. Thank you.

(Operator Instructions). Our next question comes from Zahid Siddique with Gabelli and Company.

Hi, good morning. Couple of questions. First, Tom, on the share buybacks, any changes to your view on that or your position?

No, Zahid. It's basically the same in that -- I think while it's difficult not to go out and buy the stock right now, we think the depressed levels -- liquidity is still the priority. I think that served us well in terms of the credit facility renewal, as well as the balance sheet, and that's the current approach.

Okay, and could you comment a little bit more on how you made that decision with regards to the CFO position -- what led you to make that final decision?

Yes. We -- this has been a pretty long and arduous process. It's probably been underway for five months, and we had an opportunity to really look and talk to quite a few folks. I know I personally think met with eight individuals, and we had select members of our senior team interview our top I think four or five candidates here, as well as in their location. Certainly the head of HR, Sheila Rutt, talked to many more folks than that and we screened through many.

I think the things that led us really to Brad at the end of the day were a multitude of things, both professional as well as personal. Brad and his wife have family in the northeast Ohio region and it fit both from a professional and personal standpoint, which was important to us. Second, his background both at BP Amoco, as well as what he has done at Modine was a nice blend of both the financial disciplines, but also an operational side and a solid blend in terms of international operations. So Brad was running an operation down in Venezuela and he also spent time in London. I think those are both important for us as a global player and someone that's played both an operational role and finance role.

And I think lastly the thing was, he had done quite a few things from a strategy standpoint that I thought was important that -- we have a very strong finance team and as I mentioned before, Leslie stepped up and did a fantastic job. But we're surrounded by folks within the financial group that I think are solid. So I'm not looking for someone to come in and have to run each of the finance operations. I'm looking for someone to take our operations forward, and more importantly, have an impact on the overall company operations. And from a strategy standpoint, I think he is the right guy with the right level of maturity to play that role.

Okay, and finally, with regards to M&A activity, do you see any increase within your industry, or are you looking for any type of acquisitions, or do you think you're pretty complete from a portfolio perspective?

I think in that regard, we -- I would say there's probably certain pieces of technology that are of interest to us. And there's certainly certain geographies that as we enter, we may need a distributor or an acquisition to help on the service side. But I would view most of the things that we currently are looking at, and you end up with only one of the 10 that you really seriously consider, would be what I would call bolt-on to our existing strategy. Very focused on self-service or something in the security space to help move us in the current course and speed, nothing outside of that.

Thank you so much.

Our next question comes from Ted Wheeler with Buckingham Research.

Hi, good morning. Thanks for taking the call. Two questions, if I looked at the South America revenues that you periodically disclose I guess on an annual basis, what would be the mix of those now that would be in the integrated services format?

Ted, I'm not sure that it would be anything significant in today's makeup and when I think about that, I'm thinking really of everything outside of the US, Canada, and Brazil, when you talk about the Americas. How are you defining it, first of all? Let me ask you that.

Well, you give revenues on Americas and you give revenues on North America, so I guess if you pull those apart, you would get some window on non-North America. And if I looked at the mix there, I was just wondering, you've been on the scene quite a while and I just wondered how much of those revenues is now onto the integrated services format.

The biggest piece was always Brazil. Outside of Brazil, there really was not anything up to this year. Obviously we're looking to grow that. And the one impact on this year from Brazil is one of the big government banks insourced what they were outsourcing to us. That's had a material impact on us here in the short-term. The important piece is the competency and capabilities we're taking to the other countries there and seeing they have good receptivity. I mentioned Colombia in particular, but I could mention a number of other countries there. So my expectation would be much like it is for the rest of the operation,that we're going to continue to drive service and services and that's going to be the bulk of what we do five years down the road. And Latin America has both the capabilities, the competency, and the market has the appetite for it. So I feel good about Latin America in that discussion.

If we were to just look at the ratio between product and services revenues I guess in Brazil, it would be more meaningfully toward services.

Correct, that's right. That's the model that we're driving to. At any point in time, we may have a huge product order or whatever, but over time, we're saying we want to weight 60% to 65% services as the goal.

Oh, that's -- thank you for that color. And one other just maybe housekeeping question. After two years in a row of I guess a different seasonal pattern in China, with 2008 and 2009 being front end loaded, do you think that's more normal, or are we going to go back to a more normal back end loaded seasonality, as we look at next year?

Believe me, we've had these same discussions internally to try and make sure we understand. From what we are gathering in the marketplace, and the big driver of this in most cases happens to be China. From what we're gathering from the conversations we're having with the banks, it's going to be back end loaded, or more traditionally back end loaded as we've seen in the past in 2010.

Great, thanks.

You're welcome. Jessica, I think we have time for just one more question.

Thank you. We will take our last question from Matt Summerville with KeyBanc.

I have a couple quick ones. First, in terms of cost savings, I think, Tom, you mentioned you're on track to get $35 million in 2009. What would be your thought then on 2010 and how you're framing up your general outlook for next year? And then Leslie, just to make sure I'm clear, what would be your fourth quarter tax rate for 2009?

I can take the tax rate. Basically the tax rate in fourth quarter will be about the same that we have year to date through September, which is approximately 18%.

Okay.

And, Matt, relative to the SmartBusiness continuation, while we don't have clear visibility right now, I would say it would be in the range of $35 million to $40 million next year, is the reasonable target.

And does that include what you're in the process of doing in Lexington?

Yes, absolutely. That's correct.

And then last question, you mentioned in the prepared remarks that you had a line of sight to remediating the six issues you guys have had from an accounting standpoint, if you will. I was wondering how much cost has been associated with that in 2009? And is there another layer here that goes away next year?

I'll let Leslie talk specifically about the remediation efforts. There is cost associated with this, but the flipside is we've added capabilities and we've added controls in place that remain with us. So I'll let Leslie answer in terms of where we're at from the remediation and our desire to really have all of those addressed by the end of the year. But Matt, I don't think there's going to be a significant amount relative to the control processes that we've put in place, because those are going to help us be a better organization and the individuals that we've added are going to remain with us as we continue to improve that.

That's correct. We probably have about $3 million to $4 million in costs for 2009 in this effort. We will continue some level of the effort into 2010 as we sustain things that we've built and we'll continue with further improvements, accompanying with our IT initiatives that we've got underway, so there will be some level of costs going into 2010. Thank you.

This concludes today's question and answer session. At this time, I would like to turn the call back over to Mr. Kristoff for any closing remarks.

Thanks, Jessica. I would like to thank everyone for joining us this morning on the call. And as always, if you have any follow-up questions, please feel free to contact me directly after the call. Thank you again.

That concludes today's conference. Thank you for your participation.