Diebold Nixdorf Inc (DBD) 2010 Q3 法說會逐字稿

Please stand by. We're about to begin. Good day everyone welcome to the Diebold Incorporated 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 Vice President and Chief Communications Officer, Mr. John Kristoff. These go ahead, sir.

Thank you, Sarah, and good morning everyone an thank you for joining us or Diebold's third quarter conference call. Joining me today or Tom Swidarski presidents and CEO, and Brad Richards execute vice president and CFO. Just a few notes before we in addition to the earnings release we've provided a supplementary presentation on the investor page of our website. Tom and Brad will be walking through this presentation as part of their comments today and we encourage to follow along. Before we discuss our third quality results as its porn to note that we have restructuring, impairment, and none re tune income and expense in our financials.

We believe that excluding these items gives an indication of the company's baseline operational performance. As a result many of the remarks this morning will focus on non-GAAP financial information. For a complement reconciliation of our GAAP to non-GAAP numbers please refer to the supplemental material at the end of the presentation. In addition, all results of operations reported today including prior exclude discontinued operations. Finally, a replay of this conference call will be available later today from our website and as a reminder some of the comments today maybe considered forward-looking statements internal and/or external factors could significantly impact actual results. As a pre caution please refer to the more detailed risk factors that have previously been filed with the SEC. And now with opening remarks I will turn it over to Tom.

Thanks, John. Good morning everyone. I'm very pleased with the solid third quarter operating results we announced this morning and proud of the continued efforts of our associates around the world. We remain very focused on expanding our website clear leadership in service an integrated services to drive increased recurring revenue across a global markets. Certainly the Brazil election business had a large positive impact on our results an we're very proud of the work we've accomplished in that area however, it's important to note that our core business in Brazil as well as some of our other key geographies performed extremely well as we delivered meaningful top line growth and significant improvement in earnings.

In addition, a more positive global product mix particularly in the United States resulted in notably higher product gross margins during the quarter. Our service margin continues to improve as we leverage our footprint, improve productivity and add higher value managed services to our mix of offerings. Our net debt position improved by more than $35 million from September 30, 2009 on working capital improvements throughout the remainder the year. I'm also encouraged by the double-digit increase in global orders. Each geographic region delivered order growth during the period. Which affirms our prior assessment that the industry is slowly beginning to recover. In addition, there is strong order growth for financial self-service in the US regional bank space. We remain confident in our outlook for the remainders of the year and as a result have tightened our earnings guidance near the top end of our prior range.

We are seeing increased momentum in many of the key areas we serve. For example we recently accepted eye large cash recycle order from one of the lasts banks maintenance services. It also reflects is our ability to face highly competitive pressure and a cash recycling marketplace. In Turkey we received a large order from Bankasai, one of the leading banks in Turkey. We are providing 575 customized Opteva ATM enabled with cash deposit, coin transactions and bill payments through customized software. Turkey is one of the world's fastest growing markets for ATP deployment and we are confident there due to our competitive position there due to our recent investment in a direct operation within a country. Also during the quarter we announced Navy Army federal credit union close Diebold to immaterial mobile bank. By deploying Navy Army becomes the first credit union in its Texas region with eye robust mobile program improving it's ability to compete with larger banks offering mobile services.

Diebold is providing this capability through a multi-year managed services contract along the credit union to reduce operating cost, generate revenue and help integrate their delivery channels. Additionally during the quarter we passed two important third-party audits that verify our continuous compliant with key ANSI and PCI standards for ATM security which is a major concern in our industry. While many other ATM providers perform these audits internally, we show that having third party audits provide absolutely confirmation of our compliance with these critical industry standards. Finally, we recently completed a security infrastructure up grade at the North American head quarters of Christie's Auction House in New York City. This upgrade enable the auction house to centralize its security operations reduce risk and improve events response times across multiple sites.

Now, let's look at our performance during the quarter in a geographic region action. In North America revenue grew 7% during the quarter while orders grew 9%. The momentum we discussed on our second quarter call continued into the third quarter. We experienced strong revenue and order growth in both the regional and national bank segment and the deposit automation shipments until the regional segment grew significantly during the quarters as credit unions and banks alike deployed automation solution. We are seeing similar trends in the national account space as more banks outside the nations' top three are beginning to convert their ATM networks to include de poise the automation capabilities.

Excluding the top three banks total US shipments of deposit automation terminals and modules more than doubled during the period. The television add many of us have seen from Bank of America and Chase confirm that the deposit automation is also increasing. Diebold has the unique solutions that put us in a superior competitive position with those customers who have yet to deploy deposit automation. Our technology offers under paralleled flexibility including bull, no bulk check, single note, single check or any combination at a variety of competitive price points and the results our customers are measuring on reliability up time and other key customer metrics validate our technical performance advantages. Our separate check and note merchandise rule design also enables parallel processing for faster transaction times superior performance and reliability compared to a single module design. No other competitor offers this level of flexibility and reliability.

Our competitive advantage in this area positions us well not only in North America but in all the International markets we serve. In fact, during the quarter about half of the full function ATMs we shipped globally were equipped with deposit automation capabilities. In addition we have the largest most responsive and experienced direct service organization in the industry and through our integrated services business model we offer complete out sourced solutions. This provides smaller financial institutions an avenue to quickly convert their ATM fleets for deposit automation without a large capital outlay. I'm very pleased with the continued traction and recurring services revenue we have gained in the out sourced space. The total value of integrated services contracts will secure in 2010 will surpass $100 million and represent a growth of 50% from 2009.

Another catalyst for growth moving forward is compliance with industry and regulatory requirements. For example, new requirements related to the Americans with disabilities ability will be phased in during 2011 and become mandatory on March 15th, 2012. In addition PCI standards for security that will affect ATMs moving forward. Again, we had a very strong performance in North America self-service during the quarter and feel very good about our strong order growth. We anticipate demand in this region will continue to grow.

Now let's look at our security business. Our expectation in the financial space remains tepid, especially as it relates to bank branch constructions in North America. However, we continue to see encouraging signs within our emerging enterprise security business. Growth in the none branch space contributed to overall order growth of 13% during the quarter.

In addition to the work we're doing with Christie's Auction House that I mentioned earlier we were award other significant projects during the quarter. For instance, we want won a key project related to security the world trade center site namely tower 4 and the entire transportation hub beneath the world trade center, which is one of the major critical infrastructure security projects in a country right now. These projects represent approximately $30 million and future revenue from this single site. Project wins such as these are not only important from a financial perspective but help establish our reputation as a leader in this space. In addition to enterprise we're growing other key elements of our security offering in markets outside the finance industry. During the quarter we see with McKenny a mechanical contracting and systems integration firm. We'll provide advanced monitoring services to Mckenny's customers base across the United States. As a new member of our advanced dealer program McKenny will leverage Diebold advanced monitoring solutions to help interest customers reduce cost enhance securities and increase operational efficiencies. Looking ahead we're increasingly confident that enterprise security and other strategic initiatives will help us generates sustainable growth in North America.

Now, moving on to Asia-Pacific. As we have maintained throughout the year we anticipate the region to be more back end loaded in the fourth quarter. In addition, we recorded an out of period accounting adjustment in China related to our remediation efforts that Brad will discuss in more detail in his. It's important to not that this adjustment significantly distributed to the negative year-over-year revenue comparison in the region. Orders, however, grew 5% and we anticipate a very strong fourth quarter in terms of orders and revenue. Our recently visited the region and am encouraged that we are in a strong position to take advantage of the enormous opportunities presented by the Asia-Pacific market.

In Thailand demand for deposit automation solutions is growing, particularly the area of cash recycling. We're in a position to maintain our strong market leadership with our Opteva cash recycling terminal which offers secure, reliable and cost efficient deposit automation capabilities. While visiting bane several banks including China construction bank, China postal savings bank and Beijing royal commercial bank. Those conversations under scored the importance of our continued investments to accelerate our development of hardware, software and services that address the unique requirements of the Chinese market. Our organization in China established strong partnerships with these major players. Due to China's important in this global business and the tremendous opportunity in the region, my vision is to create the same world class companies as we have built in North America and Brazil.

We experienced considerable growth in orders in revenue in the third quarter. However, this is compared to a very weak prior year. While I'm not content with our competitive position in the region we continue to have success in certain areas. In addition to the recent successes I mentioned before in Turkey and Italy we are also have a strong year in Spain, France and part of Africa. In Russia as you know our operations experienced a setback in lights of our recent voluntary FCA disclose, since Russia is a priority market for us we've decide today change our business model to a Diebold direct approach as part of this strategy we're investing on our direct operations to enhance our internal professional and maintenance services resources. This strategic initiative will strengthen our position in Russia, complement our existing operations and will also allow business to develop more effectively in the highly competitive markets in the region. However due to these factors we don't expect Russia to be a major contributor again until 2012.

Emea remains the most difficult region in terms of our abilities to complete profitably. While we feel good about the progress we're seeing in some of the areas of the region much work remains for us in Emea to achieve the strong competitive position that we have in other markets around the world. In Latin America and Brazil business remains strong with orders up 9% percent in revenue and excluding elections and lottery, also up 10% during the quarter. Outside of Brazil several countries of Latin America are performing well. Mexico, Columbia, Venezuela and Central America have been major contributors as we continue to maintain the leading throughout Latin America.

Regarding the recent elections in Brazil I'm pleased to report that we manufactured and delivered on time 195,000 voting terminals for the elections which took place October 3rd. During the election more than 113 million people voted on our technology. The technical aspect, of the election were a success. With less than one tens of 1% of the prescient having to use manual ballots, the lowest number in the history of Brazil's automated election. This once again demonstrates the significant depths of knowledge and technical resource in Brazil, and my thanks and gratitude goes out to our associates who helped make this project a success.

As you are aware the Brazilian purchase an additional 55,000 machines under the current contract. Should they decide to exercise that opposite the related revenue would be recognized in 2011. Our outlook for the region in our financial self-service business remains positive as we are seeing growing opportunities in the areas of deposits automation and ATM security. Our leading market position throughout Latin America particularly in Brazil enables us to capitalize on these growth opportunities in the coming years.

In closing I am pleased with the Company's overall financial performance and am encouraged by the signals of recovery in the market. As I mentioned earlier out remains the same and we have tightened our earnings guidance near the high end of our prior range. I am confident we will have a strong finish to the year. As we look toward 2011 there are some items to consider in terms of planning and financial assumptions. We expect a significant drop in both revenue and earnings associated with the Brazil election business. In addition, we anticipate higher pension expense, continued legal and consulting costs and resuming our 401K match so we will be working against some much these factors as we plan for 2011.

Moving forward we'll continue to work towards the vital goal of making Diebold the best in class company in generating maximum value for all of our stake holders. Our innovative approach in financial self service security and integrated services will provide break through solutions that when new business will generate even greater customer loyalty. At the same time we'll maintain our focus on implementing a sustaining effective financial controls within our global processes. Exceeding customers expectations will be critical in achieving or goals moving forwards and I am certain that with the effort the people put into Diebold put into their role on a daily basis will surpass our objectives. With that I'll turn the call over to Brad.

Thanks, Tom. And good morning, everyone. There are a number of key topics I'll discuss this morning. First, I'll cover our revenue picture for the quarter and full year. Then review our strong gross margin performance, I'll address our free cash flow and balance sheet and then detail our guidance assumption for the remainder of 2010. Finally, I will discuss our financial control environment including the out of period accounting adjustment we recorded in China related to our financial remediation efforts.

First, I would like to refer to slide 12, which shows order activities for the past three quarters. As Tom emphasized in his comments, we had very strong order growth during the third quarter. This slide shows the overall momentum building in our markets as our customers are gaining confidence and are more willing to invest capital resources in self-service technology. Turning to slide 13, total revenue was $749 million, up 16% from the third quarter of 2009 or 15% on a constant currency basis. For the quarter product revenue increased 33% as we completed the large roll out of voting machines for Brazil ahead of the nationally elections. Excluding the impact from Brazil voting product revenue grew 4% with growth in every geographic region except Asia-Pacific which was negatively impacted by a $19 million out of period accounting adjustment which I will address shortly as well as timing of business.

As we have stated previously, we anticipate strong revenue in Asia-Pacific notice fourth quarter. Service revenue grew 3% during the third quarter driven by growth in North America and Asia-Pacific. Looking at our financial self-service business on slide 14, third quarter revenue was $511 million, up 5% from the third quarter of 2009. The decline in Asia-Pacific was more than offset by growth in each of the other geographic regions particularly in North America and Emea where deed manned for de poise its automation continues to increase. In the security business on slide 15 third quarter revenue declined $5 million or 3% from the same period in the previous year. This decrease was due primarily to continued weakness in new bank branch construction while the enterprise security business continued to expand. The security business had a strong fourth quarter in 2009 and we expect that trend to continue this year. And further we anticipate our overall security business will return to modest growth in 2011.

Looking at slide 16 the total gross margin for the third quarter increased 2.1% percentage points from the third quarter 2009. The increase was primarily driven by improved product gross margin as well as continued improvement in profitability in our service operations. The product gross margin for the third -- for the quarter was up 3.2% percentage points due mainly to more favorable customer mix in North America and overall geographic mix. In service the gross margin grew 1.7%percentage points during the third quarter primarily due to continued improvements in product reliability and on going productivity. For the full year we still expect the service gross margin to be around 26%.

Moving now to non-GAAP operating expense as highlighted on slide 17 in Q3, 2010 operating expense as a percentage of revenue decreased 0.2% percentage points from the comparable periods in 2009. Operating expense in the third quarter increased $17.9 million from the prior period. Although we expected increased selling expense on the higher revenue and investment in R&D, we have been challenged by higher legal and compliance expense associated with our financial remediation efforts and FCPA review. For the full year we expect operating expense as a percent of revenue to be in the low 18% range.

Now turning to slide 18 the non-GAAP operating margin in the third quarter increased meaningfully to 7.5% percentage points from 5.1% in the third quarter 2009. In addition to our ongoing efforts to reduce cost, increase productivity and pursue profitable revenue growth the margin also benefited from the Brazil election business which carries very little incremental operating expense. Turning to the EPS reconciliation table on slide 19, GAAP EPS from continue continuing operations in the third quarter was $0.66 per share compared with $0.37 per share in the third quarter of 2009. Excluding restructuring, impairment charges and non-routine income our third quarter non-GAAP EPS was $0.70 per share compared with $0.39 per share in the third quarter of 2009. I would note our non-GAAP tax rate in the third quarter was 25.2%, in the third quarter of 2009 our non-GAAP tax rate was 14.1%. For 2010 we still expect the full year non-GAAP tax rate to be approximately 28%.

Looking at free cash flow on slide 20 as a reminder we define free cash flow as net cash from operating activities less capital expenditures. Free cash flow in the third quarter of 2010 was $56 million compared $35 million in the third quarter of 2009. Given the normal back end loaded nature of our cash flow we are still targeting free cash flow for the full year of roughly $150 million. Looking at slides 21 and 22 on working capital metrics, we continue to focus on managing our working capital. Day sales outstanding increased by one day to 47 versus the prior year attributable to growth of revenue and phasing of customer sales activity within the quarter. Inventory turns declined by .1 turns during the quarter an the decrease in the turns is due to an increase in inventory in support of a ramp up in fourth quarter production. This was partially offset by the reduction in Brazil Election Systems inventory. By year end we do expect turns to exceeds the levels we reached last year as we draw down inventory in support of a strong revenue expected in the fourth quarter.

Turning next to liquidity and net debt on slide 23, the net debt at September 30th, 2010 was $174.4 million, a decrease of $36.2 million from September 30th, 2009. Our net debt to capital ratio was 14% at September 30th, 2010 compared to 17% at September 30th, 2009. The quarter end net debt levels represent an increase of $109.1 million from December 31, 2009. In regards to repurchasing our shares we continue to take a measured approach in implementing our repurchase program. You will see that during the quarter we repurchased 126,000 of the Company's shares for our year-to-date to total of a little over 773,000 shares repurchased. There are 2.2 million shares remaining on our existing board authorization.

Now I would like to address our financial control environment and remediation efforts as shown on slide 24. As I covered in my remarks during the last quarter, we have been working for some time to a remediate material weaknesses that resulted from the extensive internal accounting review which began in 2007. We still have two remaining material weaknesses. The first is related to income tax control deficiencies that resulted in errors requiring out of period adjustments in our 2009 tax provision. Our tax team has taken significant steps to improve our processes and we still anticipate this area will be fully remediate by the end of this year. The other material weakness we're working on -- to remediate is in the area of accounting policies. As I pointed out during the last call to fully remediate this issue we had to strengthen our control procedures related to the application of the revenue recognition policy related to multiple element arrangements which involves contracts with bundled products and service components. This is a technically mechanics area which involves a complete review of contracts to ascertain the proper time to recognize revenue associated with specific deliver abilities and their related costs. The ongoing work in this area has resulted in the out of period accounting adjustment in China highlighted in today's earnings release. At this point we don't anticipate any further material adjustments to our financial statements as a result of our work in this area. During the fourth quarter we will be focused on testing our control environment in our efforts to fully remediate this material weakness by the end of this year. We will continue to communicate our progress to you and disclose any key updates in a timely manner.

Also, let me update you on where we stand with the FCPA review. Last quarter we made a voluntary disclosure related to our subsidiary in Russia in which the Company identified certain transactions and payments by the subsidiary potentially improvements Matt indicates the books and orders provision of the FCPA. While our assessment remains that the transaction and payments in question do not materially impact or alter our financial statements, we continue to conduct an internal review of our global FCPA compliance. We voluntarily self reported our initial findings to the FCC and to the department of justice. As a result the Company received a subpoena for documents from the FCC and a voluntary request for documents from the department of justice in connection with the FCC's investigation of the matter. This is a standard step in the FCPA related process that allows the FCC and the DOJ to gather information to conduct their review. And we fully expected an planned for this. We are cooperating with the FCC and the DOJ and due to the nature of these types of reviews we cannot predict the length, scope or impact, if any, it will have on our results of operations.

Again, we view our approach in this process as a continuation of our commitment to transparency and full disclosure. As we address the challenges presented to us in the coming year we will continue to embrace the high enterprise security principles of values and ethics in our relents recalls work in sustaining a sound financial control environment. Turning to our full year outlook on slide 25, as Tom mentioned in his remarks we are reaffirming our out look and have tightened our earnings guidance near the top of our range, which includes the $0.5 negative impact of the out of period accounting adjustment. Implicit in this range is a gross margin decline of a couple percentage points in the fourth quarter primarily due to a higher mix of lower margin product revenue coming out of EMEA and Asia-Pacific, as you can see, we have adjusted our revenue guidance to 4% to 5% growth from the prior 5% to 8% growth expectation with the entire revision occurring in the financial self-service line. This is largely the result of lower year-over-year growth in EMEA than we had -- than was previously expected as well as the out of period accounting adjustment in China.

So in summary I am pleased with the progress we've made in rebuilding our profitability and our return on capital employed. We are encouraged by the momentum in orders as our key markets are emerging from the global recession. Liquidity remains strong giving us the flexibility to reinvest in support of select growth opportunities and we are effectively working through various processes to address our current material weaknesses and FCPA compliance. We acknowledge this is a challenging process. However, we remain committed to elevating our financial control environment to best in class levels. And I remain personally committed to maintaining the highest levels of transparencies and balanced communications regarding our progress to all of our stakeholders. I will now turn it back to John.

Thanks, Brad. Sarah, we would like to open it up for questions at this time.

Thank you. The question-and-answer session will be conducted electron three. (Operator (Operator (Operator Instructions). Our first question will come from Kartik Mehta of North Coast Research.

Good morning, Tom. I wanted to ask you about the order growth you're seeing in North America. I think in your prepared remarks you said you're seeing order growth even from banks other than the top three and I'm wondering if you could provide more color? Are you starting so see strong doctors regional and communities banks as well or is it middle tier banks that you're seeing this strength from?

Kartik, I would say it's across the board. I think when you guys were in for the Analyst Day we talked about how many different institutions continuing I think we represent about 400institutions that have already been engage end deposits automation. Some five -- in less terminals. You know, we had about 30 or so that had 25 plus deposit automation terminals and I think what -- is crystal clear now is that momentum continues. So we are seeing it at every level of engagement. You know, for with our location we've got a number of institutions we talked to an a day lie basis coming through swell with my -- I was just down in Florida which last year for instance was really particularly hit hard. We're real pleased with the level of activity we're seeing there from year, which I think is a good sign that a state like Florida which was so hard hit in the economic crisis and we're starting to see activity in those bank and deposit automation, PCI compliance, ADA types of issues along with the whole out sourcing integrate the services piece seem to be the three or four biggest drivers of activity. So in short it's across the board, not just at the big banks.

And then, Tom, on the security business it looks like orders have really improved. I thought -- could you provide a little bit more color on that? I am assuming this is all outside of the financial institutions, but I wanted to make sure I understood where the business is really coming from.

Yes. I would say inside the financial institutions first we're still on the security front it's still a struggle. The bank branch build is not there and we don't see that necessarily coming back to any levels as I have indicated in the past. There used to be like 4,000 or so branches built on an annual basis. This year that number might be a thousand or 1,200. So you can see the dramatic impact that has on the physical and security that's tied to the -- to the bank branch build. Outside of that we have seen growth really in all those sectors. The ones I was referring to were kind of high profile enterprise security types of situations and one of the ones that was the highest profile for enterprise companies really across the US and there were companies outside the US bidding on this really had to do with the world trade center. So as you know there's multiple towers going up there.

We have secured the award for tower 4. We've also been awarded for the transportation hub which is through the port authority of New Jersey and New York beneath that which is the biggest transportation hub in the United States. You know, very complex sophisticated high end systems and that alone along with we do the perimeter -- we have a security system on the perimeter of the world trade center right now. You know, that one site alone is going to yield in the tune of $30 plus million dollars in revenue in the next coming year or so we're seeing that kind of level of -- efforts and we're putting the resource behind the critical infrastructure and shifting it away from what our traditional business was an the other thing I referenced was we have a -- very capable as you have seen infrastructure relative to -- the abilities to monitor and respond so we're taking that infrastructure and white labeling it that law other folks and I use the example of McKenny's today who is a contractor and an integrated services prior sore they have customers out there that we would not normally touch. Well, this gives them the opportunity to resell our services and for us to participate in that area and grow there in the future.

So it's a very concerted effort outside the financial industry to grow on the security side with the capabilities we have developed from the financial services sector and we're meeting with some pretty good success sees this year.

And then, Brad, you gave some color on 2011 and I'm wondering is the right way to think about 2011 if you took the higher end of the guide a just for indication of discussion it Brazil Fran core EPS number for 2010 would be somewhere around $1.80 and you would grow off of that obviously then you would have to takeout some of the other expense you have a talked about like the higher pension expense, the 401K match. Would that be the right way to think about 2011?

Yes, Kartik. I mean I think that -- that's absolutely the right way to kind of frame up the launching point as we move into 2011.

And then finally, Brad, the other income that increased in the quarter I think you reported $8.2 million compared to a negative $1.4 million last year. Was there anything that would explain that increase?

Yes. We do have in our press release kind of the break out of that other income. That's one of the increased disclosures that we put in, but I think a majority of that increase is coming from foreign currency gains and this is really a reflection of what's happened to the strength of foreign currencies relative to the US dollar.

Thank you very much. I appreciate it.

Absolutely.

Our next question comes from Reik Read with Roberts W Baird.

Hi. Good morning. Could you guys maybe talk about two catalysts it seems like there are in the North America market, the canceled FDIC fees and Tom you brought it up in your marks the ADA now has a date out to what extent are those actually having an impact that you can see in terms of improving order trends?

I think like I would bundle those under the category that ADA in and of itself probably is not a huge catalyst, but when you combine that with TCI and you combine that with do I need to think about an upgrade or do I need to think about software all of a sudden it becomes a tipping points and that's really how we have positioned it. With a lot of ADA issues it's a matter of banks mitigating risk because there may be not a penalty sitting there but the fact that there's dates there allows us to have an opportunity to have a meaningful discussion with banks and credit unions on that front and I view it as another one of the areas where it's additional complexity banks have to deal with thus this outsourcing solution of taking that off the table for them and them folks is on the ground an they do fits in very nicely and as such we run quite a few symposiums on compliance and regulatory change and again have very good dialogues relative to institutions, but I think the much bigger driver is associated really with kind of deposit automation and improving their underlying operational efficiencies and then as part of that if we can get them compliant it's kind of the icing on the cake. So I view it in that light.

And the FDIC fees is that helping with the deposit automation that you can see or no impact yet?

I would say no impact yet. I think the -- overriding issue of -- you know, I mentioned it in some of the banks or institutions we have talked to you know Bank of America has been running add in a big way relative to deposit automation and if you go to any of the industry events you have heard from various institutions of all sizes that the implementation of these has gone even better than excepted in terms of number of checks that they get by far and then also cash as well. So the fact that they're able to provide that kind of automation and service to their customer at the reliability points means that people are looking at that in a serious way and it's -- it's more than the train has left the station. It's -- there are a lot of people out there gaining competitive advantage in the marketplace. So I think that is the overwhelming issue that they're dealing with.

Okay. And then Brad just a question on the gross margins in your comments I think you said that fourth quarter with see decline really due to -- product mix, but if I do the math it seems look what you're guiding to in service gross margins they would also have to come down by -- a good chunk sequentially and just wanted to understand what may be causing that.

Yes. I mean I think what's implicit in the guidance is really the assumption that the -- you know, service margins do stay relatively stable you know from sequentially from third quarter to fourth quarter, but the product margins are going to come down meaningfully to pull the overall gross margin down a couple percentage points and it's really -- driven -- by the fact that we're seeing increased revenue coming out of EMEA and Asia-Pacific which have lower overall product margins.

But is there a reason that the service gross margin should come down?

I mean we certainly see for example going from third quarter to fourth quarter I mean we have our annual merit increase, you know, that puts a bit of pressure but, again, I think the overall driver of the gross margin is really on the product side.

Okay. And then just also on the operating expenses you had kind of alluded to it and I guess Kartik asked in his question just the -- extra expenses. It seems like pension 401K will occur throughout 2011. What about the legal fees, how much are you talking about there and when might those start to dissipate if you can forecast it at this point?

Well, you know what, I can -- what I can say here is the -- legal compliance remediation type fees that we had in kind of the third quarter was in that kind of $3 million type range. So its meaningful but as we sit here and look at -- at 2011, Reik we're not in a position really to kind of forecast out how long those will continue to run and it really is a function of the extent of the overall FCPA review that's ongoing which, again, we just can't put a time frame on that at this point.

Right. Great. Thank you, guys for the comments.

Our next question comes from Matt Summerville of KeyBanc.

Morning Brad. To get back to the last point could you -- is there a way that you can provide any additional color 2010 versus 2009 -- or 2009 how much more you're spending on both remediation and FCPA combined? Is it $10 million more, $15 million, $20 million? Did can you give some sort of ballpark figure so we can actually put some numbers lined that?

Well, Matt, I mean your question was -- again, if you just look at Q3 of 2010 versus Q3 of 2009, again, we had incremental expenditures in the area of of, again, the FCPA compliance and the financial remediation of about $3 million.

Okay. So is it fair, Brad, to annualize that and call it 2012 for the year 2010 versus the year 2009 or is it going to be something less than that. And I guess is it really too hard to see if that increases or decreases in 2011? I guess because I would be more inclined to think it comes down if your -- if you get kind much it you're able to put to bet those last two issues from a remediation standpoint.

Yes Matt, I don't think you can annualize it because simply it did kind of spool up, if you will, at the end of the second quarter when we voluntarily self disclosed so really it's -- you can't just kind of annualize and say that's the total amount. So, again, it really is dependant upon how long this doses run in 2011. I think you are right from the standpoint of a lot of monies that we have been spending on the financial remediation at this point our projections and our work plan we expect that -- the two material weaknesses to be a remediated by the end of this year so the expenditures that we've had on that should -- taper often 2011 and again it's too hard -- we can't estimate at this point how long the FCPA expenditures will -- continue in 2011.

Got you. And then, Tom, can you maybe spend a minute talking about within the Emea region you mentioned inrush I can't you're moving towards a direct operation there versus your prior strategy, but it also seemed like you guys have backed off more broadly of your -- with regards to your revenue guidance in that region for the year. You mentioned you're not content with performance, I assume that includes areas outside of Russia. More broadly what are you doing going forward in Emea from a strategic stand point to improve your performance there.

Matt's, I would say thrush I can't is a -- you know Russia is certainly a critical market but it's not the only one that impacts our guide France tray leaf standpoint you are correct that between the China adjustment and really the EMEA revenue is really what's impacted the change in the revenue guidance. The thing that kind is apparent there as we worked hard in the EMEA region is as we dealt with -- you Russia wasn't the only play with distributors, we have distributors throughout really Eastern Europe and other part of Europe as well but if I can concentrate on Eastern Europe, it really as we went through or have begun the FCPA investigation we've also are taking a look at how we deal with distributors in each of that region. That has really impacted their performance around in some cases we've severed relationships with distributors we're in the process Turkey set willing up an operation key's case we had been planning for it on an, eyed man a they are and at the beginning of the year we had done our work to get there. In these cases we have cutoff really revenue sources immediately as we begin to build-out a direct -- operation including our service operation. So in Russia's case because of the -- size an the importance of it it's going to take a awhile and we do have revenue there, but we need -- you know, we had outsourced a lot of the -- even the service revenue we got there through a distributor.

So now we're building that service operation, we're building that operational expertise, we're putting the right type of sales organization in place. So Russia is going to take some time for us to get there and along with various part ever Eastern Europe. That's been the area of really the -- biggest impact in the change over the last really 120days as a result of this. So we're working hard to put a priority focus on select countries there and do the same thing we've done in Turkey which is get ourselves direct into the regions that we need to be and controlling really our not only the way we to issues that arise from an FCP kind of investigation having more control of those operations and especially in the critical countries.

Tom, just one more final one if I can. You mentioned you were over in Asia pretty recently and you provided a little bit of color there. As we move into 2011 you know this year you've talked about Asia being more back end loaded particularly China in the fourth quarter. I get that. How are you thinking about 2011, is that going to be back end loaded as well base on these sort of preliminary decisions maybe you're having with some of your big customers there?

Yes. Because of the recent visits I can see pretty confidently I spoke to -- I mentioned a couple on the call but I spoke to many others while I was there and doing our operational review. Yes, 2011 will be a lot like 2010, which is much more back end loaded. This year happens to be fourth quarter heavy but I would say definitely back end loaded could be third and fourth or some could slip into the fourth in 2011 as well, but that's the correct way to think about it.

Thanks, Tom.

Thank you. (Operator Instructions). Our next question comes from Paul Coster of JP Morgan.

Yes. Thanks. Just on Europe. I'm sorry. On Asia for a second. So back end loaded next year. Do you see the gross margins in that region improving? How do they compare to the corporate average?

I would say the -- gross margins on the product side -- I mean you have to separate products from service because we have various service operations therein different countries who have very strong -- or maybe I would say accretive to the whole corporation service margins. On the product side I would say generally speaking and again you got do look at each country but you would say they would be dilute at this to the overall corporate averages from a product standpoint. That has a lot to do with how many competitors you find in some of the big countries there, but I would say diluted overall and then the other piece of that is that the technology matters as well so the deposit automation the margins might be a little higher than on just a typical cash dispensed type of thing but overall they would be dilutive.

You mentioned that you seek world class competency in China. What does that actually mean it us does that mean you have to invest.

Yes. What then is today -- you know, we probably have about a thousand people initial a which includes the service operation, we have two peak trees there, we have -- we have engineering capabilities. When I pair that to 3200 people, we have 200 software experts sitting in Brazil. You know we have a -- we don't have anywhere near that kind of competency in China and if these big banks start to want the level of sophistication that we've been able to drive into North America and into China, I need professional services that are much richer and deeper than they are today. I needs hardware engineering that is specific to that region much like we have in Brazil that allow us to do customization an the differentiate ourselves. So we're going to continue to invest in China in a significant way as we move forward and not just China. For those other emerging countries over there as they growth opportunities. So for instance in the third quarter do nearby I can't and Vietnam we went have that same type of enormous infrastructure in each of those countries they're going to depends upon China but we can't have China dependent upon the United States or Brazil because we can't move quick enough and we can't be responsive enough to the market and have unique market needs.

So I want to have more capability there so we -- as we put the factory there we shift alot of the supply chain over in that direction, we built engineering capabilities there we just have to continue to grow our competencies across the board including integrated services and service competencies there. So while we're in a -- what I would call a -- good competitive position today there are too many competitors that are knocking at the door in China not for us to be aggressive in terms of that being such a key global market for us. So that was the implication. It was to say we're going to continue to invest in there with technical resources like we have at our disposal in the United States and Brazil which differentiate it from just a any other market.

Got it, just switching to security business for a second. What sense is that business now originates in enterprise an other emerging applications and you obvious I are seek to go going to market in partnership with distributors and so on. What is that going to do to margins for that segment?

Okay. In the -- you're breaking it down. My enterprise security general likes peak it you bits three quarter finance and then 25% outside the. I mean that's really what we've been frabbing at. So the piece outside the financial is really where we're seeing the order growth an the activity. We do not use -- lets me separate the conversation from EMEA than the conversation from security. In EMEA we use distributors that really front end us. Here in the United States relative to security it's really Diebold. It's Diebold out in front of all this. We talk about white labeling that is somebody else can sell the infrastructure so they don't have to build this themselves so it's very different than having a distributor kind of model. So notice United States these big contracts that we're winning say at the world trade center that's Diebold people going out with Diebold installation and Diebold technology and that's really the approach we're using in the United States where we have the kind of infrastructure the brands awareness notice competence ease to do that and -- and to mover it forwards. The pieces of hey, somebody needs a call center or somebody needs a monitoring cane abilities that we've already about the I am willing to sell that at a white label to someone else but it is Diebold run and, operated and owned.

Okay, thank you.

You're welcome.

Our next question comes from Gil Luria of Wedbush Securities.

Yes, good morning. I first wanted to ask about, order, or ordered trends. If you put up I think it's slide 12, can you tell us how year-to-dateorders compare with year-to-date last year? And also I'll extend that to say how year-to-date compare with how they were insome of the better years we were in some of the better years like 2006, or 2007, or 2008, and are we starting to get back to the same levels or are we still lower than those levels?

From the -- let me see if I got the two questions right. The first one was orders year-to-date?

Yes, let me lump that into one question. How do orders year-to-date compare to orders in the first three quarters last year, and the year before that.

So year-to-date orders are up, and as you would compare that say to previous years, I would say the momentum is building Gil. It's not back in 2005, 2006 kind of levels of orders, but I think if you saw -- slide 12 you kind of get a sense of that building, and especially as you look at some of the key markets like the United States, we're liking the underline activity we're seeing there. October seems to have gotten off to a real start as well so, it feels like the fourth quarter from an order standpoint on that is going to be strong, and we're seeing the same thing in Asia. I think across the board we're feeling very good about orders and seeing the level of actives beginning to increase, which is hopeful. There's a big difference between getting activity in getting the orders as we've said in the past, and there's a difference between the order in revenues for us but you know, the momentum we talked about in the second quarter is absolutely continuing in October, and that strengthens that from where we were.

Got it, then my second question is about Brazil elections and lottery, the elections have been over for more than three weeks now, and first I wanted to see if the 55,000 option that they have and have they communicated anything about the likely hood that they will exercise that option, that next year will there be any likelihood that they will buy more than that?And then even for the fourth quarter, you still have a $10 million dollar range which is usually more than can be accounted for by lottery, so can you help us tighten that range for the fourth quarter?

Yeah, so I guess there's two aspects of that. For everyone all the call recognizes, while the major elections take place, they have all the run off elections that are taking place right now. So while we might not get the visibility, there's just as much activity going on now and it gets even a little complicated for them because they have got these run off actives that take place around, each of the states as well as at the national level. So the level of conversation we've had with them at this point is pretty minimal, because their focus is still on running these elections, so in terms of why that revenue is still $10 million is because we've got two issues there. One is part of the votingas they do these other ones, you do get sporadic orders that come in and again since they are running elections in different regions now have the ability to order, we will see some variability there.

The second thing is with lottery, the same thing happens. You know we have some lottery that we're fulfilling in the fourth quarter, but also as you get towards the end of the year, you're never quite sure if they are going to accelerate that or not. So we still have variability on both of those, and regarding 2011, or the other 55,000 the way I view that, the better we perform like we did on the first one, the more likely that is, but we really haven't had any confirmation with any direct comments from our team in Brazil or their election officials. They were very clear to us, they have got to run those elections, and they got to go right, then we'll have that conversation. But I think by the end of the year we're going to have an indication because the elections will be over and we'll have a scheduled meeting in the middle of December, and I think from there we will have a pretty solid sense of that 55,000.

Okay thank you.

You're welcome.

And that was our final question, and at this time I would like to turn the call over to Mr. John Kristoff for any closing remarks.

Thank you Sarah, and I would like to thank everyone for joining us today on the call. And as always, if you have follow-up questions, please contactme directly. Thanks again.

This concludes today's conference, and thank you for your participation.