Diebold Nixdorf Inc (DBD) 2011 Q3 法說會逐字稿

Good day, everyone and welcome to the Diebold Inc 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 the Vice President and Chief Communications Officer Mr. John Kristoff. Please go ahead, sir.

Thanks, Dana. Good morning everyone and thank you for joining us for Diebold Inc's third quarter conference call. Joining me today are Tom Swidarski, President and CEO and Brad Richardson, Executive Vice President and CFO. Just a few notes before we get started. In addition to the earnings release we have provided a supplementary presentation on the investor page of our website. Tom and Brad will be walking through this presentation as part of their comments today and we encourage you to follow along.

Before we discuss our results, as with past calls, it's important to note that we have restructuring, non-routine expenses, non-routine income and impairment charges in our results. 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 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 periods, exclude discontinued operations.

Finally, a replay of this conference call will be available later today from our website. And as a reminder, some of the comments today may be considered forward-looking statements, Internal and/or external factors could significantly impact actual results. As a precaution, please refer to the more detailed risk factors that have previously been filed with the FCC. And now with opening remarks, I'll turn it over to Tom.

Thanks, John. Good morning, everyone. Thanks for joining our call today. Once again we delivered sound performance during the past quarter showing significant improvement in our profit margins, particularly in our services business and are delivering on our commitment to generate the majority of our earnings in the back half of the year. We continue to effectively reduce our cost structure and drive improvements in our operations, while focusing on more profitable business opportunities globally. In addition, North America continued to perform exceptionally well with high demand for our financial self-service solutions. Given our market improvement and profitability and a continued strength in our North American business, we have increased confidence in our earnings outlook for the remainder of the year. As such, we are raising our full-year EPS guidance to $2.15 to $2.25 per share.

Total revenue for the third quarter decreased as we continue to be selective in the markets and deals we pursue, particularly in AMEA. And the security business for bank branches in the United States remains challenged. However, we have clearly improved our profitability through our continued focus on developing strategic relationships with customers and differentiating ourselves through high-valued services. In turn, we expect a strong fourth quarter with the year-over-year increases in orders, revenue, margin, and EPFs. Our solid third quarter results combined with an expected strong 4th quarter provide us with momentum as we look to 2012.

During the quarter, we had several key announcements regarding new innovations that help build a foundation to deliver even more value to our customers over the next several years. In August, we unveiled a prototype of the world's first virtualized ATM at VMworld. This is a very influential event hosted by VMware, the industry leader in cloud computing and virtualization technologies, and is attended by thousands of global IT professionals and decision makers worldwide. Developed in collaboration with VMware, the virtual ATM prototype removed the onboard computer from the terminal tying each machine in a fleet to a centralized computing resource. The result is not only the consolidation and sharing of resources throughout a self-service network, but also across delivery channels.

This opens the door to more effective channel orchestration. In short, virtualization will lead to a lower total cost of ownership and increased ATM up-time. The virtualization concept has not only generated a significant amount of media coverage, but more importantly, it has spawned a number of thought leadership discussions with strategic customers around the world. Virtualization represents an important milestone on Diebold Inc's road map to leveraging cloud computing technology in a financial space and will fundamentally change the way solutions are deployed in the marketplace. This technology is a game-changer for our industry.

Also in August, we announced the Opteva Flex Performance Series, the most robust self-service terminal we have ever offered. It combines traditional deposit automation capabilities, including bulk cash and check acceptance with full currency recycling, its first in our industry. It can be configured with a separate cash dispenser and recycling module all in 1 ATM. This makes it well-suited for deposit automation intense markets such as Latin America, Asia, and AMEA. And as a North American market for deposit automation continues to evolve, the Flex Series puts us in a very strong competitive position.

The dramatically improved reliability and flexibility of these terminals enables financial institutions to transform the way they manage cash at the ATM, improving efficiencies, decreasing costs, and minimizing their administrative burden. Early customer feedback on Flex has been extremely positive particularly in our key growth markets. In September, I attended a customer event in Turkey in which the Flex Series drew intense customer interest. We also conducted customer events in Mexico and elsewhere in the world where Flex created a great deal of conversation. So we're very encouraged by the early response we're seeing in the marketplace.

In services we continue to innovate by growing our integrated services offerings. We introduced the concept of integrated services more than 5 years ago. Since then, it has grown exponentially and is changing the way financial institutions think about their retail banking operations. In the US, for example, the banking landscape has shifted dramatically over the last 2 years. This has created a level of operational complexity that is driving more financial institutions to consider an outsourcing approach. Integrated services enables them to meet regulatory requirements and offer their customers the latest technology. This environment has resulted in another record quarter for our integrated services business.

In the United States, the Company signed new IS contracts during the quarter valued at nearly $90 million, an increase of more than 200% over the prior year period.

On the security front, we believe there is equal, if not greater, potential for an integrated services approach. The necessary technology to tie together physical and logical security systems has grown very complex and is creating a compelling case for an outsourcing model similar to what we built in our ATM business. We're adapting to this need by building an industry-leading IS offering which we plan to launch in early 2012. We have very strong capabilities internally that we are leveraging to build a comprehensive portfolio of services. In fact, we earned the 2011 Online Trust Alliance Leadership Award for excellence in security practices. This award acknowledges us for rigorous testing and validation of critical security technologies, solutions and services and data, and information security. This type of third party recognition provides early validation of our strong IS capabilities in the security area. These and other recent innovations demonstrate that Diebold Inc continues to lead in our industry and build a robust technology pipeline to support a broad portfolio of services as we move forward.

Now, let's take a closer look at our performance on a regional basis. In North America, total revenue during a quarter increased 4%, while overall product and service orders grew about 11% in the region. Looking at just product orders for financial self-service in the region, we saw an increase around 85%. In fact, US regional bank product orders and financial self-service once again increased well in excess of 100% and the expected revenue is beginning to materialize as we approach the end of the year. Customer demand continues to be driven by regulatory requirements and deposit automation. In fact, during the quarter, our shipment for deposit automation in North America increased nearly 50%.

Deposit automation shipments in the regional bank segment increased more than 200% during the quarter and up 150% year-to-date. This demonstrates that the market recognizes Diebold Inc as the fastest, most reliable deposit automation technology in the industry. Our superior technology coupled with our best-in-class service organization and strong customer relationships enable us to maintain and grow our market leading position in the United States.

In summary, we remain very optimistic regarding the state of the North American financial self-service market and our strong competitive position. As our large backlog in north America converts to revenue in the 4th quarter, we expect another strong quarter in terms of operating profit. The region remains our most important and profitable market. As such, North America will serve as a primary catalyst for earnings growth for the remainder of the year and into 2012.

Looking at our security business, revenue decreased 6% during the quarter. Our orders fell 9%. These results reflect of the continue to stress nature of the fiscal security market for bank branches in the United States. We expect this segment will remain weak well into 2012. You will recall in my comments during our second quarter call that we have made some significant changes in our US financial sales organization to grow the security business.

We have moved some of our top enterprise security systems experts over to the financial group as specialists to focus solely on security sales to financial institutions. And we are already seeing some early results of our refocused efforts as our security sales pipeline and the financial space doubled during the past quarter. This progress is encouraging and we believe we now have the right strategy and infrastructure in place to more successfully pursue opportunities in this space. It's important to note, however, that the sales cycle on the security side is dramatically longer than on the ATM side of the business. As such, we don't anticipate returning to year-in-year growth in orders or revenue in the security space until the second half of 2012.

Now, moving to AMEA, revenue dropped 11% as the company continued to concentrate its sales efforts on fewer markets with higher profit opportunities. Orders for products and services were down 31% in the period on a difficult comparison to third quarter 2010 in which orders grew 53%. During the quarter, we continue to make operational progress in AMEA, once again significantly reducing our losses in the region to about $2 million. We are now projecting profitability there in the 4th quarter. On a macro level, we have begun to see weakening demand in certain western European markets such as Spain and Italy while demand remains relatively strong in some of the emerging markets such as South Africa and Turkey. Given the ongoing improvements to our operation, I have growing confidence that we can now achieve modest profitability in the region for the full year of 2012 despite some of the weakening macro economic trends.

In Latin America, including Brazil, revenue declined during the quarter about 30% while orders fell 12%. Excluding election systems and lottery sales, orders were essentially flat. As I previously mentioned, we have lowered our revenue expectations in Brazil for the remainder of the year. This reflects the recent strengthening of the dollar against the Brazilian reais and the timing of a couple potentially large orders that slipped into the 4th quarter and will not revenue until 2012. We continue to feel very, very confident with our market-leading position in Brazil. Moving forward, we have an opportunity to grow our share even further as one of the large banks in the country opens up it purchases to a broad base of suppliers for the very first time.

According to the rest of Latin America, the market remains very dynamic. During the quarter we won sizable business in Venezuela, Peru, and Chili. Also, services growth in the region has been particularly strong.

Now moving on to Asia-Pacific. Revenue increased 48%. However, excluding an accounting adjustment in the prior year period, revenue increased 17%. Orders for products and services declined 9% as a large order in China slipped into 4th quarter. However, we received this order in October which positions us for a strong 4th quarter order entry. Third quarter revenue growth in the region was driven primarily by our integrated services business particularly in India, where we now monitor 40% of the ATMs in the country. I'm very encouraged with this growth as it reflects our strategy to grow services aggressively in Asia and protect our profitability. This enables us to differentiate ourselves from the local hardware manufacturers that are driving down product pricing throughout the region.

In regard to the massive flooding in Thailand over the past week, I wish to send my thoughts and sympathies to our associates who have been impacted by this disaster. We have a very dedicated team of 500 people in Thailand, and my heart goes out to them and their families. From a business perspective, we have mitigated any immediate impact on our supply chain though the situation is still evolving.

Given our performance in key markets and increased profitability in our business, we feel very confident with our earnings guidance for 2011. As we look toward 2012 there are some items to consider in terms of planning and financial assumptions. Overall we expect modest top-line growth driven primarily by the Americas. However, we anticipate a drop in both revenue and earnings associated with the Brazilian business. In addition, we anticipate higher pension expense.

On the plus side, we expect modest profitability in AMEA for the full year and demand and profitability remains strong in North America. As I said earlier, we expect to see growth in the security business in the second half of 2012. Finally, we anticipate similar overall seasonality in revenue and earnings to what we had in 2011.

So to summarize, I continue to feel extremely confident in the direction we're headed. We're delivering on the expectations we established throughout the year to generate the majority of our profit in the third and fourth quarters. And our efforts to improve all aspects of our operations and continually to deliver value-added services are showing up positively from a profitability perspective. Customer intimacy is fundamental to Diebold Inc's growth everywhere we compete around the globe.

We have proven time and time again that our core intellectual capital enables us to lead the industry in terms of innovation. With our Flex Series, we continue to lead in the area of deposit automation. We were first to introduce the concept of integrated services and now we're at the forefront of virtualization in cloud computing in the financial self-service space. Diebold Inc associates on the front lines are leveraging their thorough understanding of the market and our current prospective customers to help drive business and build value for our shareholders. Their expertise and commitment gives me great confidence that we are on the right track to a successful future.

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

Thanks, Tom, and good morning everyone. Before we review the financial results I will comment briefly on our profitability during the quarter, our progress regarding our restructuring efforts in AMEA and our share repurchase program. To reinforce Tom's comments, we have significant improvement in margin performance this quarter. This is proof that our business strategies are beginning to take hold especially in our services business where we have seen consistent improvement over the past several years. We achieved this improvement despite lower revenue during the quarter from Brazil elections, AMEA and our security business. Overall, we expect to continue our improved profitability momentum into the fourth quarter which positions us well as we look to 2012.

We continue to execute on our restructuring efforts in AMEA. During the quarter, we once again significantly reduced our losses in the region which amounted to about $2 million. As I mentioned in our last call, we have identified $8 million in cost reductions for 2011 and we are on track to hit that target. Given our progress on restructuring and our core country focus, we fully expect to turn a profit in AMEA in the fourth quarter. I am encouraged by the results we have generated to date and absent any further setbacks in the banking industry, I am more confident we are in a position to achieve modest profitability in AMEA for the full year 2012. This expands our opportunity for consolidated year-over-year earnings growth.

Also during the quarter, we were active in our share repurchase program. Given the weakness in our share price earlier in the quarter and our growing confidence in the Company's future outlook, we felt it was prudent to step up our share repurchase efforts. We have consistently maintained that we would be opportunistic in our approach and during the quarter we repurchase 1.7 million shares at an average cost of $27.55 per share. Leaving just 700,000 shares on the current Board authorization. We intend to continue to be opportunistic in our share repurchase program for the remainder of the year.

Now to review our financial results for the quarter, let's turn to slide 17. Total revenue declined 5.2% with 3% positive impact from currency. Product revenue declined 13.8% while service revenue increased 3.2%. As I already mentioned, the decrease in product revenue is primarily the result of a $43 million decline in elections and lottery revenue in Brazil from the third quarter of 2010. The order picture outside of North America in the third quarter appears weak due to timing in various areas, particularly China and Brazil. However, we expect fourth quarter worldwide orders in our financial self-service and security businesses to be up significantly with year-over-year growth in virtually every region in the world. This sets us up nicely as we build momentum for 2012.

Looking at our financial self-service business on slide 18, third quarter revenue increased 2.6%. Growth was primarily the result of strength in North America driven by regional banks adoption of deposit automation solutions and addressing regulatory requirements. In the security business on slide 19, third quarter revenue declined 6.3%. The market for bank branch security equipment continues to negatively impact our overall revenue. Within the financial industry, where we have significant brand equity, we continue to focus on growing our enterprise security business, as well as laying the groundwork for integrated services. As Tom indicated in his comments, we have seen a significant increase in our sales opportunity pipeline and we anticipate returning this business to top-line growth in the second half of 2012.

Looking at slide 20, the total gross margin for the third quarter was up 1.4 percentage points. Product margin increased due to a more favorable customer and geographic mix particularly in the Americas and AMEA. The service margin grew mainly from continued productivity improvements and cost-savings initiatives during the quarter. Moving now to non-GAAP operating expense, as highlighted on slide 21, third quarter operating expense as a percentage of revenue was 19.1%, up 100 basis points from the prior period on lower revenue. On a dollar basis, however, operating expenses decreased from the prior year period. We expect that trend to continue in the fourth quarter despite an increase in R&D investments as we continue to focus on tight cost control. For the full year, we expect operating expense to be around 19% of revenue.

Now, turning to slide 22, the non-GAAP operating margin in the third quarter was 8.2% representing our highest quarterly operating margin in nearly 3 years. As Thomas noted, these results clearly show our commitment to reducing our cost structure while focusing on more profitable business opportunities globally. We expect 4th quarter operating margin to exceed 8% which will result in a full-year operating margin of around 7%.

Turning to the EPS reconciliation table on slide 23, non-GAAP EPS moved from $0.73 per share in the third quarter of 2010 to $0.69 per share in the current quarter. Our non-GAAP tax rates moved from 25.2% in the prior period to 21.2% in the current quarter. This is due to a favorable outcome from an IRS audit which resulted in a discrete item that lowered our tax expense. As a result, we now expect our full year tax rate to be approximately 26%.

Turning to slide 24, free cash flow for the quarter was $30 million compared with free cash flow of $57.5 million in the third quarter of 2010. The decrease in free cash flow is primarily the result of a significant increase in inventory in support of our forecasted fourth quarter revenue. As we look at the full year, we anticipate normal seasonality with strong free cash flow in the 4th quarter. For the full year, I still anticipate we will generate around $150 million in free cash flow supported by stronger earnings, inventory draw downs, and a normal pattern of accelerated collections towards the end of the year. Looking at slides 25 and 26, the day sales outstanding increased from the prior year period by 1 day. Inventory turns decreased from the third quarter of 2010, again as we accommodate the substantial revenue we expect to deliver in the 4th quarter. Working capitol remains a top priority and we anticipate seeing normal seasonal improvements in the fourth quarter.

Turning next to liquidity and net debt on slide 27, net debt was $232.2 million, an increase of $57.8 million from September 30, 2010. The increase in net debt during the third quarter was primarily the result of our share repurchases. Our net debt to capital ratio was 22% at September 30, 2011, compared with 14% in the prior period. We expect to generate the majority of our cash flow during the fourth quarter and anticipate the net debt at year end of approximately $50 million. This is an impressive leverage position considering it includes during the calendar year around $75 million in dividend payments and over $100 million in share repurchases.

In terms of the outlook for 2011 on slide 28, we are revising our revenue outlook to reflect lower financial self-service revenue expectations in Europe and Brazil. This reflects the recent strengthening of the US dollar as well as the timing of some orders which has pushed revenue into 2012. We now expect total revenue to be essentially flat with financial self-service revenue increasing 2% to 4%, and security revenue unchanged from our previous guidance which is flat to down 3%. Given our improved margins, increased confidence in the fourth quarter, and a lower tax rate, we are raising our full year non-GAAP EPS guidance to be in the range of $2.15 to $2.25 per share. As we move into 2012, I am confident in our ability to deliver solid results with our backlog in orders providing a sound foundation for growth. With that in mind, as Tom indicated in his remarks, we have provided some considerations as you start to think about modeling 2012.

One additional point to consider regarding top-line growth is that we continue to be disciplined in the type of business we pursue in order to drive return on capitol employed to 15% in pursuit of building long-term shareholder values. As a result, we have consistently demonstrated our willingness to trade revenue growth for profitability.

To conclude, I am encouraged at the direction we are heading. This is supported by extensive, strategic work we have done related to our business in AMEA, our security operations, and our global financial self-service business. In addition, the operational strength we have developed are affectively driving execution on our cost-savings initiatives. Our restructuring efforts in Europe are providing a solid foundation for the region moving forward and our processes for financial controls are sound. These factors coupled with our financial strength provide me with tremendous sense of confidence as we look to capitalize and execute on the core strategies that we have put in place.

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

Thanks, Brad. Daniel, we would like to take our first question at this time.

(Operator Instructions) Kartik Mehta, Northcoast Research.

Tom, as you look at the North American market now, specifically the US market, and the orders you're seeing in the regional banks and maybe some of the conversations you've had with your customers, any sense of how long you think this upgrade cycle could last?

Kartik, let me put it in two frameworks. One would be in terms of what's happening from the compliance standpoint. Obviously there's a lot of activity that is tied to compliance that -- they have some deadlines here in the first and second quarter of next year. And so I think that has been a big driver, but as you can see for us, it's been 4 consecutive quarters now from a regional bank space of seeing product orders up well in excess of 100%, so the comp will get more difficult in the fourth quarter. But we still see a very strong fourth quarter ahead of us.

The other piece of that I look at in terms of deposit automation, which I think is another key driver underneath that. And again, the way I have been framing that up is -- if you look at the big banks and top 25 verses the smaller banks and credit unions, we're seeing heavy activity with credit unions and small banks. The top banks you'd say maybe are 40% of the way or 50% of the way in terms of completing this roll-out. When you look at the total opportunity there, I think with the credit unions and the smaller community banks, we're probably only 20% to 25% of the way there. So, I think deposit automation for me is a much longer turn. People are going to get themselves equipped relative to compliance immediately, but the issue on deposit automation and integrated services, both of those I see underlying strength for quite a period of time.

And then, Tom, as you look at EMEA, what are you anticipating for a loss out of the region for 2011 now? It seems like you are ahead of plan on your restructuring, and that might have been the result that the orders were less than expected out of EMEA. So, I was just wondering if you could update us on where you are in terms of restructuring, and what you expect for a total loss out of the region?

Sure. Certainly all the regions for us, we continue to have -- we work the hardest there in terms of making sure that we have clear and good understanding because of our performance in the past. So, as you have seen throughout the year, we have been able to reduce our losses. My expectation would be that the fourth quarter yields some type of modest profitability, maybe $2 million to $5 million range.

And in essence, we think about that in terms of 2012, depending on where the fourth quarter comes in, that is about probably a $0.10-or-so pick up for us in 2012 as we think about getting to breakeven point for the full year in 2012. So, we're seeing positive signs. We need to see more of them. We need to string more performance together in EMEA because of our position there, but we think we're on the right track, and I think that is the dimension I would think about it in.

And then just one last question, Tom, on Brazilian elections, you mentioned in your slide that you expect a drop in revenue and earnings. I'm wondering -- is the drop in revenue earnings mean that it will go to zero, or are you expecting some revenue and earnings out of Brazil in 2012? Any way to give an idea and a range?

Yes, and I think we'll have a much better answer for you on the next call because we're in the process right now of finalizing production. Right now, it's going exceedingly well. They are in the process, and have notified potential suppliers, that they are going out through a bid process again. But probably in the late November, December timeframe, we would have some better insight. But we're modeling in, it doesn't go to zero, we're thinking about half of what it was this year, and again, I think we'll have a much better perspective on this on the next call.

Thank you very much, appreciate it, Tom.

Matt Summerville, KeyBanc.

Couple questions. First, as we think about either sequentially or year over year, however it's easier to talk about, the improvement you've seen in both gross profit on the product and services side, is there any way to frame how much of that is being driven by cost take-out versus mix improvement versus maybe input costs going against you?

I'm not sure I can -- I mean, I'll look to Brad. I'm not sure I would have a solid answer to break it up that definitively right here, Matt.

Maybe the way I would respond, and again, I think you can see that for the full year, roughly, our product margins are going to be in the 25% range, service margins 27%. And I would think that the product margin, certainly we have ongoing costs, but that is driven by mix, where the service is certainly where you're seeing the continued drive of cost, cost savings, Matt.

And then with regards to the comment on Europe making money in the fourth quarter, I'm just trying to clarify. Is that really a change in how you were forecasting the business, or is that more a reflection of seasonality there? I'm trying to gauge what has evolved over the last 90 days that makes you comfortable committing to that.

Yes, I would say, first of all, seasonality always plays a big role in our business overall, but in EMEA more so than anywhere else, just because of the way the EMEA market is for us. Second of all, I would say it has firmed up. So, for us, we're not talking about a major swing, but we're talking about really more confidence, and we were talking about trying to get a run rate of profitability or run rate of 0 to a 2, and we think maybe we're going to do a little bit beyond that, so I would say it's firming up.

And then also, it's just timing as well. So, you saw in the third quarter, revenue was down. Some of that has to do with just some delayed installations that now move into the fourth quarter, so it's going to assist our fourth quarter, but really doesn't change our overall premise there.

And then just lastly, if you look at the backlog that you guys have been building up in the small-bank market, how much visibility with that customer base, if you look at just where your backlog is today, do you have into 2012 at this point? And I guess what I am trying to get a feel for is -- how much of that, those 100%-plus order numbers that you have had for the last year, how much of that has revenued at this point?

I would say that we still have quite a ways to go, relative to the revenue side of the equation. So that unlike the larger banks where you are mapping out 6, 9, 12 months, with a lot of the credit unions and smaller banks it takes a little bit longer to revenue because you have to work through maybe a processor or a third party to help assist in that regard. So, it takes a little bit longer, thus I think we've got quite a ways to go from a revenue standpoint. And again, as I indicated, we're expecting a very strong fourth quarter relative to this same space again.

Thank you.

Gil Luria, Wedbush Securities.

I wanted to follow up on that. So, the US ATM business is the most important business. It's the business doing the best, and has your highest margins. What revenue growth rates do we have for that business, not just on the regional side, that entire US ATM business? What growth rates do we have now? And is the fact that you're signing a lot of these smaller banks to integrated services deals means that that growth rate can carry on into next year?

Gil, it was a little bit hard hearing, I don't know if that's the phone or the connection. But I think the essence of what you're asking about is maybe the underlying strength of North America and the growth rates going forward?

Yes, the growth rates for US ATM. What are those revenue growth rates for US ATM right now? Can those carry into next year based on the ramp of the integrated services business?

Yes, I would say -- let me answer the back half first. Really the growth rates in terms of carrying into 2012 -- absolutely. With the kind of backlog that we are talking about, and where we've been and where we're going, we think we're going to be in very good position there. I would say when you look at it specifically in terms of regional banks and community banks and credit unions, the half of the universe that you would call outside of the top 25, those growth rates have been the 10% to 15% range. And I would expect that we would continue to see that from a revenue standpoint as we go forward. And then the second half of the year we would expect, in North America specifically, to start seeing some pick up in growth on the security side as well.

And then on Brazil, in terms of the business that's available there, NCR announced that they have the Bradesco business. Are there other large banks that have activity there that you think you could have some wins at the end of this year, going into next year?

Oh, absolutely. Let me clarify Bradesco, first of all. Fortunately for us, they certainly have an agreement with NCR, but much like they did this year, they ordered several thousand units from Diebold, as well as some other non-ATM-like devices. So, my expectation will be that we'll continue to do business with Bradesco. It certainly wouldn't be the level that we have in the past, since we probably have maybe 25,000 or 30,000 ATMs in that environment.

The second thing is, in our relationship with Bradesco, we didn't get the service parts of that contract. They had their own internal service arrangement. So, I look at that very differently than I do some of the other banks where we're not only talking about the technology and doing services, but we're also doing the critical piece of service.

So, we see pretty good opportunities here in the fourth quarter for us that we think we're in very good position with, relative to the Brazilian market. And we have traditionally done business with all 7 or 8 major players in the market. I expect that to continue. I would expect the weighting to be different going forward, in terms of which banks and the size of those orders, but we think the fourth quarter can be pretty good to us from an order-entry standpoint in Brazil.

That's great, thank you.

Julio Quinteros, Goldman Sachs.

Hi, this is actually Roman Leal in for Julio. First on the European market, can you give a little bit more color on the state of -- I think you called out Spain and Italy. I may be mistaken, but I think those are the 2 countries you called out. Any more color on the market there? Is this a broad-based weakness, or just something -- more competition?

Yes, I would say really when you -- I use those 2 as an example. I think the macro issues are the big overriding issues in EMEA that we are facing, and the banks and the uncertainty of what's happened there, and the financial institutional structure there, and all the issues that they're facing, is really the big driver there. So, unlike where we see the United States, that people have moved on to understand the actions they're taking. There, we still see capital being tied up a little more than it had been. But by the same token, you've seen the improvement we have made relative to the type of activities that we have there, and also improvement in terms of revenue that's more profitable for us.

So, as you look at our mix around the world, we have much lower exposure in EMEA than we would in the United States. So as such -- as the United States moves, we're going to move a lot more reflective of that. EMEA, I still think there is some time to work through all the issues that they have there. And as I mentioned, we have seen some strength in maybe some of the emerging markets, but the mature markets, we still think it's going to be a while before we really understand what the picture is, and their movement to automation. So, while we have some success there, it's smaller for us. The most important success we have there is improving the profitability picture, and that is how we're looking at it.

Got it. I completely understand that it's a smaller business there. But in terms of the spend trends, is this more of a -- is it just the fact that deposit automation of the major drivers here in North America are just not in Europe? Or is this more of a CapEx situation?

No, the same drivers are there as in the US. As a matter of fact, in some areas they are much further ahead in terms of automation. This is more of a Cap Ex thing. And I think, again, for us, you'll see the fourth quarter -- we'd expect revenue and orders to be up in the fourth quarter. And again, some of that has to do with timing. So for me, it's much more the macro issues that are being addressed there, and we feel very good about refocusing back on select countries where we think we can make a difference, and do it in a profitable manner, and that is really our focus in EMEA.

Okay, and then one last question on the security business. What gives you the increased visibility or confidence that that business is going to show some positive growth in the second half of next year?

So, I think a couple of things there. First of all, you split the business as a physical security versus electronic security. When we report those externally, you see them as one number, and you see security going down. In reality, electronic security has been relatively flat, if maybe not up a tick for the full year, whereas you're going to see physical security is actually down. So, when we separate those two, we've got confidence of what's happening there.

The second thing is, as you have seen, we have been able to do some pretty impressive things outside the financial industry. When you talk about the results we've have in the World Trade Center, and the World Trade Center Transportation Hub, and some of the most sophisticated buildings around the world that we have some expertise in. We've taken those same capabilities and oriented them back now to the financial sector. And as such, when I talked about our pipeline growing, it's our pipeline with financial institutions. We're now taking our enterprise security and our logical security skill sets to the financial space, and I think we're meeting with very good conversations, and I think very good success. So, while it may take longer for some of that to turn into actual orders and revenue, and that is why we're talking about the second half of next year, based on the conversations and the opportunities that I have personally been involved with, I know the capabilities we have and the interest level back to our sweet spot, which is the financial institutions, we feel very confident in what we can do there going forward in 2012.

Thank you.

Zahid Siddique, Gabelli & Company.

Couple of questions. The first one is on pensions. I know you talked about higher pension expenses into 2012. If you could give us some color around that?

Yes, Zahid, and let me just start out with a reminder of our pension situation. Our qualified plan, we were roughly underfunded about $50 million as we finished out 2010. So we've got a pretty strong funding situation of the plan, but what is driving the potential increase in the pension expense is the change in the discount rate, which has raised the overall present value, if you will, of the benefit obligations. And so, this year we saw a $5 million increase, again, driven by lower discount rates, and I think for next year $5 million is probably a good place holder.

And what is the discount rate for 2012 versus 2011 versus 2010?

Well, I just -- I'm not -- I would rather not get into the details of what it is, but just in aggregate, it's been going down by about 1% per year the last couple of years.

Okay, great. Any updates on the FCPA progress?

Yes, so, really where the -- what we've been reporting to you is basically that we plan to wrap up our internal review towards the end of this year. We're on track to do that. And then our plans are to sit down with the FCC and Department of Justice, and try to resolve this matter. I can't predict, obviously, at this point, how that process will work, but we're on track to complete our internal review as we previously disclosed.

And that is by the end of this year, internal?

The internal review by the end of this year, correct.

Okay, and then you don't have a sense of when the full review will conclude? So, sometime maybe in 2012?

Yes, again, the full -- again, our review will be done, but again, we have to sit down and obviously discuss this with the FCC and the Department of Justice, and again, I just can't predict at this point how that process will unfold. But I suspect it will obviously spill into 2012.

Sure, and my last question is on the margins. I noted the gross margins improved in a sizable manner in the quarter. Looking out into the next several quarters, is that something that you believe would be sustainable?

Well, certainly what I would say is that we continue to show nice progression, if you will, on our service margins, and so we would expect service margins to continue to improve. At the same time, as you know, although our product margins have been strong, that is really being driven by mix. So, there's going to continue to be price pressure globally on our product margins, so I wouldn't say that we're going to continue to see significant improvement in the product margin side of the business.

Thank you.

(Operator Instructions) Paul Coster, JPMorgan.

I think most of my questions have been answered. However, integrated services as it applies to securities, can you just explain to us what this is, and what it does in terms of revenue model and visibility in time?

Yes, so, it would be comparable to what we're doing on the ATM side. Let me reflect on that first, and then I can take you to the security piece, because it might be easier to understand. As people have been dealing with -- again, we introduced these concepts 4 or 5 years ago. In Brazil, we actually introduced them 10 years ago. In essence, people outsourcing their ATM network to us, which includes governance; it includes audit; it includes running the ATM itself, processing transactions, routing transactions; it includes software, downloading software and the whole bit. So, in essence, we take over the operational side of running the business for them.

When you think of the security business, think of the same thing, that today we already do quite a bit of monitoring for banks. Most of that monitoring we've been doing is associated with a retail bank branch. You take that same concept, and realize that security now is moving like the ATM business has been, in terms of everything is networked, everything is connected and everything is IP-based. So now we're going back to institutions and really looking at -- many institutions today still do their own monitoring. They run their own networks, and that could be just burglary, that could be fire and burglary, that could be energy. And so, over those tracks of the monitoring, whether it be events and also the video aspects of that, we're now looking at handling all of that for institutions. We have several institutions that have an increased appetite for us to do that, as they've faced cost-structural issues as a result of what banking is undergoing here in the US.

And you could pick up the paper every day, and people are talking about them focusing back on their core business, what can they do? There's pieces of their operation that we can actually take off their hands. We don't have to run their whole security operation. It's really the technical IP pieces, and it generally starts from a bank branch network, but then you start thinking about their operation centers. How do they handle that? And so, we have now been able to leverage what we have done with big facilities like the World Trade Center, and building on that capacity, and doing the same thing for large complex buildings, as well as many diverse facilities that a bank would have. So, in essence, they'd be turning those capabilities over to us.

And we see a big appetite for this, much like we did 5 years ago when we introduced that concept in the US. It took several years on the ATM side to get the traction, but now we have moved quite a few of our people that are security experts into the financial space, calling on financial institutions along this line. And again, as I mentioned, our pipeline has improved dramatically as a result of this, thus we know there's really a market for it, and the competencies that we have developed, both on the ATM side as well as what we have been doing previously, in terms of the security infrastructure, is there. So, if people come to Canton, when we have customers that visit, we take them up to a center where we monitor things 24 hours a day, 7 days a week, and just adding on to that is going to be what we do on the security side of the business.

And so, does it change the revenue model at all?

Yes, so, in essence what it does is -- most of these contracts end up being multi-year contracts. And what it ends up being is, relative to being a run rate for a 2- or 3-year period, that we have operational contracts for. And so it becomes much more steady services, rather than a 1-time product sale. So again, it helps the service business grow and services grow. And second of all, it helps in terms of margins as well, and the consistency and quality of our [earnings].

And lastly, just to be clear here, you earlier said that the physical security market is down. Is it intentionally excluding that from the scope?

No, this would say -- the basic premise is going to apply across the board. It's just our opportunity is really going to be the electronic IP-based kinds of things, and not necessarily on the physical side of things. But again, if the physical side of branch building and that activity ever picks up, we'll be in good position to take advantage of it. But really the growth that we're going to see is really going to be on the IP electronics security side in the financial space.

Okay, thank you.

Matt Summerville, KeyBanc.

Just a couple quick follow-ups. First, I wanted to talk a little bit more about free cash flow. In order for you guys to get to $150 million, you need about $250 million in free cash in the fourth quarter. And just looking at slide 24, you have never really been quite that strong. So, Brad, can you help define or maybe put in buckets how you build to that $250 million number, and what your degree of confidence is there?

Yes, and if I can just help you maybe, Matt, just a little bit with the math, how about $240 million. But I know you're trying to be big picture, but every dollar is going to count here because I think you point out, obviously, this is a steep hill to climb. Let me say a couple things. One is, in the fourth quarter, and again in that $240 million, we are working on a modest-sized tax refund that we expect to come in, so that is going to provide support for the $240 million number. But I would also say that we've spent 2011 looking very, very hard at our underlying processes, and specifically, for example here in North America, working on our annual maintenance billing process. We think we've done a lot of improvement to that, and again, we think that will provide a year-over-year improvement in our overall collections. So, that is just an example of process work that we have going on, and is going on globally to really help us meet this target.

And then Brad, maybe just a follow-up. On the inventory side of things, given the timing on the Brazilian elections and some of these other orders coming through, would you say inventory is going to be the biggest component of that, or would these other items that you just highlighted with me?

No, I think the inventory, you can see from our cash flow, in the quarter we built nearly $50 million of inventory, which again will be drawn down heavily in the fourth quarter. So again, I think it's a combination of the process work on our collections, tax refund, the underlying earnings, and then obviously the significant draw down in our inventory.

And then, as we think about 2012, is there any sort of framework you can throw out there, Brad, as a placeholder for what we should be thinking in terms of an effective tax rate? And as you guys are talking to the Board, would you anticipate reloading that share repurchase for 2012?

Yes, I think the effective tax rate -- again, this year we had guided to 28%. We took it down, as I mentioned, in terms of the settlement of the past audit. But I think the 28% is a good placeholder, and in particular because we will be driving more earnings out of our North American business here in the near term, which has a higher effective tax rate. So, I still think the 28% that we have been using is a good long-term proxy.

As it relates to our share repurchase program, we've got 700,000 shares left on that. This is something that we review with our Board on a quarterly basis, and would be looking to do that after we have completed the year. We understand how our cash generation has come out, and we also understand what our acquisition pipeline looks like. Because we have good capacity here, and we are wanting to make sure we maintain capacity to continue to be able to invest in the business. So that will be an early 2012 discussion with the Board.

I think the other thing, Matt, in that regard, is when you think of how we're thinking about it, first of all is we've got a lot of opportunity we talked about in terms of innovation here. So, reinvesting in the business from an R&D standpoint, a marketing standpoint becomes very high priority for us as we go forward, and again, want to keep changing the game. And we are talking about adding services as we build these infrastructures, so I can see us continue to invest heavily on that front. Certainly we're committed to the dividend, the M&A activity as well. So, we're going to look at it holistically, and certainly it's been an important part of our plan this year, and will probably play a role going forward, but I want to make sure we look at it holistically.

Thanks, guys.

And with no further questions in the queue, I would like to turn the call back over to Mr. Kristoff for any additional or closing remarks.

Thanks, Dana. And thank you, everyone, for joining us this morning. Just one additional note before we sign off here -- I wanted to mention that the Diebold investment community and industry analyst conference has been scheduled for February 22 and 23 in New York City. A save-the-date message will be going out in early November with more details, but I just wanted to put that date out for you here this morning.

So, thanks again for joining us, and as always, if you have follow-up calls, please don't hesitate to reach out to us directly.

Again, that does conclude today's presentation. We thank you for your participation.