Diebold Nixdorf Inc (DBD) 2012 Q3 法說會逐字稿

Good day, everyone. Welcome to Diebold, Inc. 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.

Thank you, Dana. Good morning and thank you for joining us for Diebold's third quarter conference call. Joining me today are Thomas 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'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 you to follow along.

Before we discuss our results, as with past calls, it is important to note that we have restructuring and non-routine expenses 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 be focused 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 SEC.

And now with opening remarks, I will turn the call over to Tom.

Thank you, John. Good morning, everyone. While our business in the third quarter was sound from a top line perspective, we experienced a number of unique challenges relative to profitability.

First, we had a forecasting issue in our North American operation that caused us to over-estimate our profitability going into the quarter. Our business in North America remains robust as we turned in 9% revenue growth during the quarter; however, a shift in mix significantly impacted profit margin on several sub-segments of the business.

Second, North American service margins were adversely effected by lower than expected billed work and continued investments in our Integrated Services platform, software, and productivity tools.

Finally, a couple of very large financial self-service projects with government banks in Brazil have been pushed out into 2013. Brad and I will address each of these factors in more detail in our comments this morning. As the result of the revenue mix shift in North America and project delays in Brazil as previously announced, we have reduced our earnings expectations for the full year.

Despite these mixed shift and timing issues, we remain confident in the fundamentals of our global financial self-service business, which we anticipate to grow at 8% to 9% this year or 12% to 13% on a constant currency basis. While product margins are under continued pressure, we expect our service margins to return to the positive sequential trajectory in the fourth quarter.

Also, I'm encouraged by our security business performance during the quarter, which grew nearly 8%, security of the key strategic growth initiative for our Company, and we're beginning to gain increased traction in this space. As a result, we have tightened our full-year security revenue guidance within the higher end of our prior outlook. I remain confident in our ability to execute on the many opportunities on the horizon for Diebold and deliver profitable growth led by our services capabilities both in the near term and beyond.

Now, let's look at our regional performance. In North America, revenue grew approximately 9% with growth across the financial self-service and security businesses. Civil orders for product and service decreased slightly off a strong comparable to the prior year when we experienced a double-digit increase in orders. However, order entry was in line sequentially with the first and second quarters on the dollar basis.

As I mentioned earlier, we had a greater than expected drop in profitability based on customer mix shift taking place on the heels of the upgrade cycle in the regional bank space related to ADA and PCI compliance. To put this impact in perspective, in a given year, a 10 percentage point mix shift from regionals to nationals translates to about a $10 million drop in operating profit and an impact of approximately $0.10 in earnings per share.

Likewise, when we saw a shift in the opposite direction in the first quarter, it resulted in dramatically higher profitability for the Company. However, this shift toward the national account segment should not be interpreted as a weakness in the market. The manner remains strong for deposit automation, led at this stage by the national account segment, which carries lower margins. Yet, it's important to note that regional bank self-service revenue has grown 94% on a year-to-date basis and grew again during the third quarter, but at a significantly lower rate than the growth we experienced at the national account level.

On the integrated services front, we continue to focus on building our infrastructure and extending our competitive advantage in the market. The integration of the Toronto-Dominion business, the largest outsourcing deal in the industry, continues to progress. We are on schedule to begin transitioning their machines and we will have more than 500 ATMs, or about 10% of their total base, on our systems in the fourth quarter. In addition, TD has decided to replace all its competitive terminals with Opteva units.

Also during the quarter, our integrated services competencies enabled us to replace the ATM hardware of our primary competitor in a number of regional accounts, including Capital Bank and Midland State Bank. This exemplifies the added value we bring to our customers in helping them manage their retail delivery aspects of their operations.

To support this transition and further develop our IT capabilities in the services space, during the quarter, we teamed up with Verizon to open state-of-the-art data centers located in their Terremark centers in Texas and Virginia. This integrated advanced data center capability, which leverages Verizon's reach, reliability, and global scope, will increase our performance. This is one of the key investments we've made in our integrated services operation.

Reflective of the recent trends we are seeing in the regional bank space, the total value of contracts we signed for IS in North America during the quarter was below the prior year period. However, we still expect to reach $300 million in total contract value this year. I am also encouraged by the growing services portion of our IS contract, which now stands at approximately 70% of total contract value.

This is important given the recurring nature of these services, as well as the fact that many of these services are incremental to our traditional offerings. We will continue to focus intently on drawing this segment of our business. Looking to 2013 and beyond, we are focused on bringing new solutions and innovations to the market. We recently introduced several such innovations at this year's BAI Retail Delivery Conference. In the mobile innovation space, we displayed various transactional and authentication technologies.

We also showcased our remote deposit capture application, which delivers efficiency to check processing and improve customer service by allowing consumers to transform photos of checks into digital deposits. In addition, we exhibited our cashless person-to-person payment capability, which enables consumers to make electronic payments to other consumers or businesses via mobile devices. These software-led services are a critical component of our future growth in IS.

From a branch automation perspective, our Concierge Video Services technology was very popular with customers at the show. This brings video technology to the ATM to visually connect bank personnel with the consumer to resolve problems, answers questions, or fulfill marketing opportunities. Unlike competitive offerings, our Concierge Video Service can be added to existing ATMs, eliminating the need to invest in a dedicated terminal.

This solution was developed in concert with Co-op Financial Services, which has more than 3,500 credit union members, 30 million card holders, and 4,700 shared branch and locations. We have planned several pilot installations for this technology in the fourth quarter and are very excited about its potential moving forward.

These sorts of innovations combined with advances in cloud-based services, 4G network capable ATMs, and the Opteva Flex series, all introduced during the past year, place us at the leading edge of technology in our industry.

Looking at the security business, revenue grew at 8% during the quarter, while total orders grew at a similar rate. Since Tony Byerly joined the Company, he has been working to realign the organization, build the sales team, invest in a software-led services platform, and grow the pipeline of opportunities. I am encouraged that these efforts are beginning to have an impact as we generated double-digit gains in both revenue and orders in electronic securities during quarter.

We are also shifting our strategy in terms of where we are focusing our efforts within electronic security, with greater emphasis on growing recurring services within the financial space, and less emphasis on one-off enterprise implementation projects. These recurring services will provide us with a more stable stream of revenue moving forward.

So we are comfortable with where we are regarding our strategy and improved execution in security and our renewed confidence in our ability to deliver growth in 2012. Therefore, we have tightened our revenue growth projection within the high end of the prior range and expect to deliver 3% to 4% revenue growth for the full year.

Now looking at Asia Pacific, revenue was 2% lower in the period but up 4% on a constant currency basis, as service growth was offset by lower product volume. Service growth in the region was primarily driven by China where we saw solid growth in maintenance contracts, managed services, and sales of consumables. The decrease in product volume was mainly attributable to timing of business in India and Southeast Asia, partially offset by the growth in China. Total product and service orders increased well into the double-digit range, driven primarily by growth in China and India.

In China, we are seeing consistent demand in tier one banks and we are making notable inroads with the tier two and three regional banks. The demand we are seeing is not only for our traditional ATMs, but for our high end cash recycling solutions. In India, the government began initiative for the state run banks to nearly double the number of ATMs over the next few years by outsourcing to private companies.

We opted not to bid on any of the deals as a primary deployer given the risk in significant upfront capital required with unknown returns. However, we are currently pursuing opportunities to provide hardware and maintenance services to the various companies acting as primary deployers. We've already won a number of such contracts and we are well-positioned to capture as much as 30% of the install base of the total project.

We anticipate the business resulting from the (inaudible) of activity in India will be diluted from a product margin perspective. However, the services aspect of the business is appealing given the good service margins and recurring revenue inherent in these agreements we are making.

This strongly supports our managed services strategy in India without taking on the risk and capital investment required to be a primary deployer. So I feel good about what we are doing in Asia, not only from the level of activity we are seeing, but from the type of business we are doing and how it fits within our strategy of growing services globally.

In Brazil and Latin America, revenue decreased 15%, or 2% on a constant currency basis, due to the decline in year-over-year elections revenue in Brazil. The decrease in elections revenue also resulted in substantially lower product gross margin. Double-digit revenue growth in Latin America was more than offset by the decline in Brazil due to the timing of projects and the impact of the Real. Orders in Latin America and Brazil grew in the low single digit range.

In Brazil, several factors led to the delays in a couple of very large government bank bids for ATM replacements. These include a government bank worker strike, shifting priorities of internal projects within the banks, and, finally, a general slowdown of government activity leading up to the elections, which took place earlier this month. While these delays were a primary contributor to our reduced outlook for the year, we expect a strong year in our Brazilian operations in 2013. We are confident in our market position, technology, and services capabilities in Brazil, which positions us well for 2013 and beyond.

In Latin America, outside of Brazil, we continue to experience double-digit growth in revenue and orders throughout the region. I am encouraged that a portion of that growth is being driven by new integrated services contracts. During the quarter, we signed several significant contracts, including one with a multi-national Spanish bank in Peru, several others in Columbia and elsewhere within the region. As we look to the fourth quarter and beyond, we expect to continue to deliver strong growth in these emerging markets.

Looking at EMEA, revenue declined approximately 4% but was up 6% on a constant currency basis. Orders experienced strong double-digit growth as we saw continuing momentum in deposit automation and recycling driven by our Opteva Flex series of ATMs. Business was especially strong in South Africa and Saudi Arabia.

Also, one of our recent wins in Europe was the direct result of our growing software and service competencies in EMEA. We delivered XFS based, customized software solution with nearly 100 advanced Opteva units with cash recycling and coin deposit capabilities.

All these significant orders are positioning EMEA well for the fourth quarter and provide a solid backlog for 2013, and we're still on track to achieve a modest profit for the full-year in the region.

Brad is going to provide more specifics on our balance sheet, but I want to take a few moments to discuss our strategy in terms of cash use. You are aware of our increased investments in IT and services infrastructure, shared services, and new product and application developments to reduce cost, increase our competitiveness, and help generate organic growth. In addition to these ongoing investments, we are placing greater focus around developing a more robust M&A pipeline.

To that end, we recently announced strategic acquisitions in two key growth areas, logical security and services. In September, we expanded our security expertise with the acquisition of GAS Technology. GAS is the leading Brazilian internet banking, online payment, and mobile banking security company. It serves most of the country's leading financial institutions and protects nearly 70% of the internet banking transaction in Brazil. We are confident that GAS will be a meaningful addition to Diebold as we expand our logical security expertise.

Earlier this year, we announced the acquisition of Altus, an industry-leading multi-vendor service provider in Turkey. Altus provides IT services to the financial sector through 32 service centers covering approximately 80 cities in Turkey with a team of more than 150 professionals. Turkey is one of the largest ATM markets in the world, growing at more than 15%. Altus provides us with a service infrastructure necessary to capture on the opportunities in this market.

As I think about our acquisition strategy, we intend to step up on our activity in the coming quarters and focus on security and services opportunities in our existing markets with a very strong financial and strategic criteria for acquisitions and a rigorous process from opportunity to integration.

As we put a heightened focus on growing our business both organically and acquisitively, we have had to reprioritize where we invest our capital resources. After analyzing our near and long-term growth priorities, it has become clear that investing more than $100 million in a new headquarters facility is not the right priority for the business at this time. Therefore, as we announced earlier this morning, we are indefinitely suspending our plans in that regard and do not plan to pursue new construction options for the global headquarter facility either in Ohio or elsewhere.

To address the competitive pressures in our global markets and allow the kind of continued investments necessary to grow our business, we have a number of initiatives underway to address our long-term cost position. Brad will get into these efforts in more detail during his comments, but we are sharply focused on keeping our cost under control and taking the right steps to gain more efficiencies throughout our operations.

So to wrap up my comments this morning, while we are frustrated by the various challenges we encountered during the quarter, we are confident in our long-term strategy and continue to execute against that strategy. Investments we are making today to enhance the solutions we deliver to the market, reduce our long-term cost structure, and expand our services infrastructure will bring value for years to come.

The global financial self-service market is growing in key geographies and we are encouraged by what we are seeing given the growth of our international order book and the security business it's beginning to show extremely encouraging signs of progress. We also continue generate very strong cash flow and are confident in our ability to continue that trend moving forward.

With the investments we are making in the business and the acquisition strategy we are following, I am certain that we will successfully execute on our growth plan and deliver superior return to our shareholders.

With that I will turn the call over to Brad.

Thanks, Tom, and good morning, everyone. Before I get into our quarterly financial results and outlook for the remainder of the year, I would like to provide some insight into the preliminary third quarter results we reported last week, which were well-below our expectations.

As Tom, mentioned we missed our internal projections for the quarter, largely due to customer mix issues within our highly profitable North American regional business. In addition, we experienced an adverse impact due to lower billed work service volume and additional cost associated with the investment in our integrated services platform. While we have good visibility into our backlog and the related scheduling, we were not as sharp around accurately projecting the timing and margin associated with specific installations during the quarter, which in turn adversely impacted margin.

We realize there will always be timing issues in terms of what period revenue is recognized, but we need to do a much better job forecasting our service cost and the margins associated with our scheduled backlog. We are addressing our processes to improve our forecasting efforts and execution moving forward.

Looking at our third quarter results, we reported non-GAAP EPS of $0.39 per share, compared to $0.69 in the prior year. There were a number of factors which led to deteriorating gross margins and higher operating expense during the quarter. As a result, we have lowered our full-year non-GAAP EPS guidance to $2.25 to $2.30 from the prior range of $2.50 to $2.60. I will walk you through these factors in greater detail in a few moments.

Our revenue outlook, however, remains largely intact as our core markets, which while cyclical, remains sound. We did experience two large bank customer delays in Brazil, which impacted our top line assumptions for the full year. Thus, we tightened our full-year revenue outlook to growth of approximately 6% at the low end of our prior range.

Despite these delays in Brazil, we still intend to grow our financial self-service revenue 8% to 9%, or on a constant currency basis 12% to 13%. This is notable considering the current global economic environment and competitive pressures in our industry. Our strong balance sheet anticipated free cash flow supports our continued growth in key areas such as software, services, and electronic security.

For example, as Tom mentioned, we recently made two strategic acquisitions, GAS in Brazil and Altus in turkey, both of which are highly synergistic and accretive to the growth of the Company. Acquisitions such as these enable us to build upon the organic growth we are generating.

As we think about our capital allocation strategy, we are focused on driving the long-term growth of the business and return on capital employed of 15%. Investments that support these strategies take precedence. To this end, we recently made a necessary decision to end the pursuit of our new world headquarters facility.

Now to review our financial results. Turning to slide 16, total revenue was $710 million, flat from the third quarter 2011, including a negative currency impact of approximately 6%. The third quarter revenue was driven by strong performance in both our financial self-service and security businesses in North America, offset by the $21 million decline in election revenues in Brazil. For the quarter, service revenue increased more than 3%, while product revenue declined 4%.

Looking at our financial self-service business on slide 17, third quarter revenue was $531 million, an increase of 1% due to national account activity in North America, as well as continued strength in Latin America, excluding Brazil, where we enjoy a strong leadership position. Service revenue grew approximately 2%.

The security business on slide 18 took a positive turn this quarter with revenue of $154 million, an increase of approximately 8%, and our electronic security business grew 14% in the quarter. This gives further credence to our execution of the software-led services strategy in our electronic security business. This is the third consecutive quarter of sequential order growth, which builds our confidence in the long-term growth prospect for our electronic security business. As a result of our increased confidence, we tightened our full-year security revenue guidance at the top end of our previous range to grow 3% to 4%.

Turning to slide 19, total gross margin for the quarter decreased 3.1 percentage points from 2011, with an equal decline in both product and service. We experienced pressure on product gross margin during the quarter due primarily to the tough comparison we had within the high margin Brazil election business. Product gross margins were also impacted by an unfavorable customer mix in North America and EMEA.

Turning to service growth margins, as Tom noted, there was lower volume of break-fix service revenue in the quarter within our North American business. We also continue to invest in our integrated services platform, software, and productivity tools. Finally, we experienced a mix issue in relationship to more low margin installation revenue versus higher margin billed work and contract maintenance revenue. The higher installation revenue was the result of increased product revenue in the quarter.

Moving on to non-GAAP operating expense as highlighted on slide 20, in the third quarter, operating expense as a percent of revenue was up 40 basis points. This was primarily due to our increased investments in R&D to support future offerings in the financial self-service and security segments. For the full-year, we still expect our operating expense to be around 18.5% of revenue as we leverage our operating expense structure over greater volume in 2012 versus 2011.

Let me provide more detail on what we are doing from a cost structure perspective. On slide 21, we are taking a broad long-term view of our efforts. In order to offset ongoing competitive pressures in our global markets, we have a number of initiatives underway to address our cost position.

As part of these efforts, we are realigning hardware and software development resources in global centers of excellence, geographically situated to best meet our R&D needs in key international regions, building out our global IT and business service center in Hyderabad, India, and aggressively implementing advance service technologies and productivity improvement tools primarily in our large service organizations in North America and Brazil.

As a result of these and other strategic cost reduction initiatives, we are making a conscientious decision to reduce our headcount by approximately 500 full-time contract and open job positions, primarily in Brazil and North America. Many have already taken place and the majority are expected to be complete in the next 30 days. While these are very difficult decisions, they are necessary to align our overall cost structure within the needs of the business.

We are also continuing to execute on our smart business 300 cost-savings initiative, which is currently focused on areas of indirect spend. In doing so, we are freeing up more resources that will allow us to make investments in growing the business. We continue to be diligent in these cost control efforts in order to incrementally improve the long-term profitability of the Company and we will expand and accelerate these initiatives as appropriate.

Now to slide 22, non-GAAP operating margin in the second quarter decreased to 4.7% from 8.2% in 2011. We now expect our full-year operating margin will be in the high 6% range. This is a setback to reaching our margin improvement target. While we have driven marked improvements in EMEA, North America, and the Latin America division, Brazil has been highly dilutive to our margins this year due to the cyclical nature of our FSSs and voting businesses there.

Turning to the EPS reconciliation table on slide 23, non-GAAP EPS moved from $0.69 per share in the third quarter 2011 to $0.39 per share in the current quarter, which I will elaborate more on in a moment. Our non-GAAP tax rate moved up considerably from 21.2% in 2011 to 30.6% in 2012. The 9.4 percentage point increase is attributable to non-recurring discrete items, reducing the rates for third quarter 2011. Greater income from regions with higher tax jurisdictions increased the effective rate for the current quarter. Our full-year EPS guidance assumes a non-GAAP tax rate of around 27%.

Slide 24 provides some additional insight on the year-over-year decline in non-GAAP EPS. As shown, EPS declined by $0.30 in the third quarter 2012 versus the prior year. A large portion of the decline came from North America as a result of the stronger mix in national account revenue, as well as the increased service investments we covered earlier. Another significant impact came from the year-over-year decline in the Brazil voting and lottery businesses. Finally, the higher tax rate also contributed to lower EPS in the quarter.

Turning to slide 25, free cash flow decreased $41 million in the third quarter, while year-to-date free cash use improved $29 million. As such, our free cash flow is more balanced this year, so we still anticipate a strong fourth quarter. Our improvement in free cash use year-to-date, coupled with continued enterprise initiatives, continues to put us in a position to generate approximately $170 million in free cash flow for the year.

Looking at slides 26 and 27, day sales outstanding increased by six days from the prior year to 54 due to geographic composition in receivables and timing of payments. For the full-year, however, we expect DSO to be in line with the prior year. Inventory turns improved during the quarter versus the prior year, and while we are at the highest third quarter turn level in several years, we have room to continue to improve inventory turns as we move forward.

Moving next to liquidity and net debt on slide 28, we finished the quarter in a net debt position of $151 million, a reduction of $81 million from the net debt position at September 30, 2011. Our strong balance sheet also puts us in a position to continue preserving the record for the longest standing consecutive dividend increases in North America.

In addition, during the past several years, we have returned a solid 3% to 4% dividend yield, reflecting the financial strength of our Company and our steadfast commitment to our shareholders. During the quarter, we did not repurchase any shares. While we have roughly 2.4 million shares remaining on our repurchase authorization, our investment priorities at this point are our dividends, acquisition activity, and reinvestment in the business.

In our full-year outlook for 2012, as shown on slide 29, we expect revenue to increase approximately 6%, in line with the lower end of our previous guidance range of 6% to 8% due to customer delays in Brazil. We are also lowering our full-year guidance for financial self-service revenue to grow 8% to 9%, including currency, again, due to customer delays in Brazil.

Security revenue, on the other hand, has been tightened at the top end of the range to grow 3% to 4%. We are lowering our full-year 2012 non-GAAP EPS guidance to be in the range of $2.25 to $2.30 from the prior guidance of $2.50 to $2.60. Again, our earnings guidance assumes a full-year tax rate of 27%.

Slide 30 gives further insight into the reasons behind our lower guidance for the year. The changing customer mix in North America, service investments, and other items that I mentioned earlier represent a reduction of $0.17 to $0.20 per share in our outlook. The remainder of our reduced outlook is attributable to government bank delays in Brazil for financial self-service deployment.

Turning to slide 31, I would like to outline some key considerations regarding our 2013 outlook. First, a macroeconomic environment of slowing growth. Second, we anticipate modest top line growth with difficult comparisons in North America and revenue growth in Latin America and Brazil and the security business. Next, we expect continued downward pressure on products margin, especially considering the year-over-year mix shift in North America. However, we also expect improvements in service margins compared with 2012 as our investments in that space continue to take hold.

Finally, we expect higher healthcare and pension expense; however, we also expect benefits from the cost containment actions we are now taking. Net-net, we are positioning the Company to drive operational improvement and grow earnings per share in 2013.

Moving to slide 32, I would like to provide a brief update on our compliance initiatives. More than two years ago, we made a voluntary disclosure related to certain potential violations of the Foreign Corrupt Practices Act. This prompted an extensive internal investigation that has cost the Company more than $20 million. The process has also been disruptive to our business, causing significant setbacks in certain markets such as Russia, Eastern Europe, and China.

This journey has been arduous, but today we have a much more robust compliance program, which gives us confidence that we are conducting our global business in a compliant manner. Currently, we are in very active negotiations with the Department of Justice and the Securities and Exchange Commission working toward a resolution. While we cannot predict the timing or nature of any potential settlement at this point, we will continue to provide updates on key developments moving forward.

In continuing our commitment to transparency, during the quarter, one of our Brazilian subsidiaries was notified of a tax assessment of approximately $130 million. This assessment primarily relates to allegations of prohibited importation of certain ATM components. We certainly take all matters related to this issue seriously; however, we disagree with the assessment and re vigorously defending our position.

These type of tax audits in Brazil are not uncommon as many companies have experienced similar assessments. We are currently assessing the impact of this tax uncertainty. Due to the lengthy administrative and judicial processes, this issue will likely not be resolved for many years. We will continue to provide updates on this matter as necessary.

In closing, we are disappointed in the results we've delivered during the quarter. We are addressing our internal processes to improve our forecasting efforts and gain a more accurate view of the business moving forward. The fundamentals of our business remain sound.

As I mentioned earlier, we expect our financial self-service business to grow 12% to 13% on a constant currency basis. In addition, I am encouraged by the high single-digit growth we saw in our security business during the quarter, and we remain on track to deliver on our guidance that we set at the beginning of the year within this segment.

Moving forward, while we continue to encounter pressure from a product margin perspective, the investments we are making in service and IT infrastructure will enable us to continue to improve margins on the service side. The cost improvement steps we are taking are strategic and measured and are reflective of the investments we have been making to address our cost position.

We are continually working to align our operations with the strategies and long-term targets set within our financial framework. Our revised revenue guidance for 2012 still puts us above our long-term goal of 4% to 6% and we are making strong progress towards achieving our target of 15% sustained return on capital employed.

Lastly, our solid balance sheet puts us in a position to capitalize on growth opportunities and deliver sustained shareholder value. With that, I will turn the call back to John.

Thank you, Brad. Dana, we will take our first question now, please.

Thank you. (Operator Instructions). We will go first to Kartik Mehta with Northcoast Research.

Good morning, Brad and Tom. I wanted to ask you, Brad and Tom, I think you both mentioned the opportunity to do some acquisitions, and I wanted to get your thoughts on what areas you are going to focus on and if you believe, based on the evaluations you are seeing out there, if these would be accretive to earnings or if that would take a little bit longer to achieve?

Kartik, I will start and frame up the areas that we're looking. I would say there are probably four areas of focus. One, what you would call the traditional break-fix maintenance type of services. Certainly, those types of acquisitions are easy to fold into an existing operation. We think those can be accretive very quickly.

The second type of acquisition would be in the security space. That may include an acquisition on the technology side. It may include an acquisition relative to the services or capabilities, but security certainly is a top of mind issue for us, and as we generated the momentum here, we think there are some opportunities we are going to be evaluating in that space.

The third I would point to have to do with the what I would call where GAS is in the services space. So technologies that we fold into an integrated services offering would be very appealing to us. And sometimes, these are smaller technology companies with the capability and this one happened to be around security on the internet banking space. But there are other ones in that type of genre that we would be looking at. And, generally, those would be smaller.

And then I would say the fourth would be in key geographies and we have identified six to 10 key geographies which really drive the businesses that we're in long-term and anything in those areas much like we did with Altus to give us the strength and capability to compete more effectively in a market we think is critical would be the fourth area that we focus on.

Thanks, Tom. And then the question on Brazil. I think, Brad, in our prepared remarks, you talked about Brazil and obviously that's having a year-over-year tough comparison from a margin standpoint and I am wondering from the orders you have seen and maybe just having a perspective of that geography, what percentage of the EBIT do you think you could get back in 2013 that you've lost in 2012?

Certainly. Kartik, as we showed on slide 30, I mean we estimated the impact of the government bank delays somewhere in the neighborhood of $0.08 to $0.10 per share and we are watching the order activity very closely on these bank delays, but our assumption is that we would get that back in 2013. That was part of the 2013 consideration slide that we showed. And, again, there's lots of puts and takes for 2013, but certainly we would expect that to come back in 2013.

And then just a final question, Brad. You maintained your cash flow guidance even though you took down EPS guidance, can you just talk about maybe what areas are helping you so you are able to maintain your cash flow guidance that you have confidence you can get to $170 million in 2012?

Certainly, when we started the year, we signaled about $150 million of free cash flow and as we've seen our performance this year continue to improve, we took it up to the $170 million. We probably have cut back a little bit on the capital investment side, which will certainly help us achieve the $170 million. But if you look, Kartik, at the slides again, there's quite a bit of momentum on the receivables here in the fourth quarter like we normally have, but also the inventory performance, albeit it's not where we wanted to be, it's been performing better than where we were a year ago this time. And so it's those factors that give us confidence on the $170 million of free cash.

Thank you very much. Appreciate it.

We will go next to Gil Luria with Wedbush Securities.

Good morning. I wanted to ask a couple of questions on the state of regional bank market and your business there. Do you expect to be, as we are now after we had the ADA spike earlier in the year, are we still up year-over-year in regional banks? So third quarter over third quarter last year, so is that deposit automation upgrade cycle still happening for regional banks?

Yes, Gil, if you would look at year-over-year just regional banks space and just self-service, we are up year-over-year. I think what we are seeing is the rate that we're up is decelerating.

Got it. And then in terms of competitive wins and losses, can you help us with a comparable metric to the one that was mentioned by NCR a couple of weeks ago. In terms of banks that you haven't done business with over the last three years and you did business with this year, so how many banks have you added this year that you haven't done business with over the last three years?

Yes, Gil, I think that number is about 700 this year; I think it's a little north of 700. And as you might expect, a lot of those would be institutions that are small and as a result of ADA and PCI have to make an investment, and those would be in that very smallest category in terms of the regional bank space; we have sub-segments there. But overall, I would say maybe even a more important indicator would be revenue growth year-over-year were up 94% there, which to me looks at the broader breadth of the capabilities of a lot of the regionals that are a little bit bigger than a one or two ATM acquisition. So we look at a number of those type of factors and it kind of give us a sense of how we are trending.

Got it; that's very helpful. And then on the managed services business, you are ramping up TD, which is by far the biggest customer you've had to date, and there seem to be some incremental cost that your taking on. First question is how long is it going to take for you to add the required infrastructure? And then the second part of that question is once you ramp up to take on TD with their full base of ATMs, are you going to have to make that kind of investment every year to take on more customers or is the investment you're making this year scalable for you to bring in other customers?

So I'll answer those pieces and then, Brad, you can chime in if need be. So first of all, one of the comments I think Brad and I both made was our service margin in the fourth quarter are going to return back to what we consider normal levels for us. As you saw, the second and third were down. Part of that had to do with the investment that we're making here relative to the TD. So in essence, we have completed the vast majority of investments we're making here, so I don't expect that to have any of the impacts it has had.

The second piece of that is because of the way we've made those investments, they are truly scalable. So we're leveraging, as I mentioned, Terremark centers with Verizon in that partnership. We have our space within their facilities and can leverage their capabilities. And so while it took us a while from an investment standpoint to get up to speeds for someone that size and scope and technical capabilities that TD needed, we're now at that level and we would not expect to have to make an incremental investment like we have as we'd put on any size accounts going forward.

The other piece of that is it will help us because we will begin moving once we have Toronto-Dominion up and running. We will begin moving all of the IS businesses that we're currently running on our system over there, which would really allow us to, again, focus on cost and take some of that out and allow us to be much more efficient going forward.

Got it; thank you very much.

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

Good morning. Couple of questions, Tom. First, one of your initial remarks was that you had a forecasting issue in North America, you overestimated profitability. I am a little lost as to actually how that happens in this day and age with the IT systems we have. So, is that a human issue, an IT issue, is this lingering ERP stuff? I mean, really dig into how this happened.

Okay. Brad, do you want to?

Yes, Matt. Good morning. Certainly with our IT systems, we have very, very good visibility to the backlog, and we have got good visibility to backlog split between national and regionals, and we have decent visibility as to when that backlog is actually going to be scheduled and installed. What we found this quarter though is that our visibility to the margins within that backlog, we typically had been using more of kind of an average for the regional space, average for the national space, and that typically has worked well for us and that the North American business has been very predictable. It didn't work in this quarter and so we have taken additional steps in our forecasting process to really show the backlog, show it scheduled, but then show the margins, the actual specific installation margins, on that backlog. That's the fix that we have made.

Okay. And is that just -- think bigger picture about Diebold, we're looking at kind of three years of flat EPS. If we go back even six years or so ago, revenue is about where it is, operating profit non-GAAP is about where it is. What do you guys do from here? You've gone through SV200, you've taken a lot of cost out. The margins just aren't moving. What should give us confidence that the lights sort of get switched on and margins are on that sustainable track to 10% here?

Matt, that is a question we have been very focused on from a long-term standpoint. Certainly, when you go back that period of time, you look at what happened during the financial crisis and you look at how you come out on the other end. So the world is very different today than it was five or six years ago, and we recognize that. The cost side of the equation is certainly one piece of that, and as we've outlined today, there are a number of actions we're taking there.

There's a number of productivity tools like OpteView Resolve, which really helped on the service side. So while you think of SmartBusiness 100 or you think of infrastructure pieces, probably more important is on the productivity side. So as you can see this year, our margins on the service side this quarter were down significantly compared to where they have been historically, but we're expecting to end the year and exit, say the fourth quarter, closer to 28%, and our expectation is to continue to grow those over the next several years with the productivity tools I'm talking about.

The other piece of that is you mix in the IS efforts that we've put in place. So the higher services capabilities from -- and, again, GAS fits into this type of discussion we're talking about, those capabilities of providing a Toronto-Dominion with endpoint security, with providing with content distribution, other things outside the traditional hardware and software. It is really the software services that becomes a key ingredient for us, and those are the capabilities that we've been building and those margins are higher.

Certainly, if you look at the third element, the product margins are going to continue to be under pressure and that's why we put so much emphasis on building agnostic systems and tools on the back end, which is very different than we were three or four years ago or five years ago relative to being able to improve someone's network regardless if it's a Diebold device or someone else's device, hardware agnostic services capabilities. And that applies not just to the self service business, but the security side of the business, and that would be the last element that I would add.

The security side of the business, specifically electronic security, gives us a lot of opportunities that we are now focused on. And while we don't have a lot of track record there on electronic security side to put in perspective, in the financial services segment here in the US where you have physical security and self-service business with over 50% market share, the electronic security side it's single digits, so it's 8%, 9%, 10%.

We've got a lot of opportunity there because of lot of capability there but we've now oriented a lot of the organization in that regard. So that's the direction we are headed and why we have confidence that we are going to change the margin perspective going forward, and beginning in 2013. We are not talking about wait till 2014 or 2015, but 2013 beginning to change that trajectory.

Thank you. And then just one last quick one. It sounds like you guys have essentially tabled the idea of buying back stock even at $30 in favor of going out and acquiring stuff. Can you just flush that out with me in terms of how you are thinking about that and why you have chosen to go that path?

I think what we are seeing in the marketplace is evidenced by the, too, that we recently completed, there are some pretty attractive assets out there and some of that can be very accretive to us relatively quickly. And while they may not be large in size, they give us some competitive capabilities to compete. So the one in Turkey -- certainly, Turkey is a market that we've entered, we are not a one or two player; we are a three player there. Adding a service operation with a kind of breadth and scope that they have allows us to participate in the market that's growing 15-plus% a year or so.

We see that as being a very strategic acquisition right within the core of what we do. Likewise, we are looking at United States relative to those types of operations and in other key markets around the world. So I would view this as good investment in our key business to allow us to accelerate growth and achieve the kind of margin performance that we are looking to achieve through some accretive acquisition. Brad, anything you would add?

No, I think that covers it.

Thanks, guys.

We will go next to Julio Quinteros with Goldman Sachs.

Hi, it's actually Roman for Julio. First, I guess it's a follow-up to Matt's first question. When you look at North America and you look at the order growth that you've seen in nationals versus regionals, I guess nothing surprised you on the pace of order growth; it was more on the margin there. But with the visibility you have in the recent quarters and the time lag that it takes from that order to convert into revenue, what do you think the revenue impact in terms of nationals versus regional is for the next two quarters? Should we expect this mix shift to continue for the first half of 2013 or beyond?

Yes, I would say that that mix shift will absolutely continue to shift more toward national less toward regional as we go through 2013. The big fast upgrade cycle relative to ADA PCI, which drove a lot of business in the regional, really has come to an end. Now, we are back to more of a regular paced replacement and deposit automation being the big driver in regionals. But as you get to the smaller regionals, they are less and less equipped to get to deposit automation as fast as the mid-tier regionals all the way up to the nationals. So we see the mix continuing to move in that direction for sure.

And is there any change in the magnitude of the mix over the last few quarters? What's the delta between order growth in nationals and regionals?

I don't know if I have a percent I can quote right now, but certainly it is significant in terms of what it is. We will probably get back to you with the actual mix kind of change. I don't have that off the top.

The order activity certainly supports (inaudible).

Okay, and then one last one. In Brazil, and I know that the cost reductions there or the headcount reductions there is probably very consistent of what you are doing corporate-wide, but given that you expect Brazil to bounce back, I am just a little confused. Are you timing for a potential slowdown in that region or again is this just a more consistent with what you are doing across the board? Thanks.

We're not expecting a slowdown at all. I think in Brad's comments, you'll see in the slide, we really expect Brazil to have a very solid 2013. This is more in programs we put in place over the last six months, nine months to recognize the inevitability of the issues we're going to face on the products from a long-term systemic standpoint and making the necessary adjustments there.

Secondly, as you move more in those services realm of things, we need to improve from a productivity standpoint. So part of this are the tools from productivity standpoint as you move to services and part of it is the reflection of the product environment that we see going on. So these are necessary important steps for us to be a leaner, healthier organization going forward.

And, Roman, I would reinforce -- this is something we have been looking at and we have been working on. The government bank pushout, certainly, this is not a result of that. We have had a third party in helping us really look at process in order to look at where we can drive productivity primarily in the corporate overhead of our Brazilian business. So this is not a reaction to the quarter; this is a reaction to the product pressures that Tom spoke to as well as, quite frankly, reacting to operating in a relatively high inflationary environment. We have to look at this.

Great, thanks.

And we will go next to Paul Coster with JPMorgan.

Thanks. I get the point about how forecasting was a little defective in terms of anticipating the margin mix, but maybe I misunderstood a prior conversation, but I also got the impression that there was a sort of fairly significant change anyway in the mix between national and regional accounts quite later in the quarter. If there's any truth to that statements, can you talk about the linearity of the change there and what it might be suggesting or why would, for instance, regionals be slowing down at this point in time?

Paul, let me address that. A lot of that had to do with coming off the PCI, ADA upgrade cycle. As we look out going forward and what we see in the order book would suggest that it's going to continue movement from the smallest banks that were just buying an ATM to meet compliance and regulatory requirements to more of the deposit automation replacement cycle. And when you look at that, you look at the top three banks, and then we look at the next four through 25. The banks four through 25 are moving aggressively and they are moving forward with deposit automation capabilities.

The next set of regional banks, the next with 1,000 is different than the last set, which is probably the remaining 9,000. The next 1,000 we are seeing activity there, but it is slower than the tier above them. And in the bottom group, the bottom 9,000, we are seeing that as taking longer. So the amount of revenue may be pretty comparable, the amount of activity may be just as high, but again it is really tilted toward the top 25 or maybe the top 100, and then the second tilt would be the top 1,000. And below that, we are seeing it being much slower and it taking longer. So that would be kind of consistent with your question.

Can you -- I mean, what do you think the underling reason for that difference would be?

So the difference is pretty simple for a lot of these folks. Number one, the complexity of moving the deposit automation requires a back end capability whether it is the processing or in house capability. For a lot of folks, that becomes a big obstacle, a big stumbling block, which is why we try to get them in integrated services. That's really where integrated service is oriented. And when we talked about integrated services this quarter, we said really year-over-year we are down, but actually the number of customers is up because a lot of it is oriented toward this. It's just the number of sites is down and the number of revenue associated with those sites goes down. So that's why integrated services for us is so important; it continues to move there. But I would basically say they have got regulatory issues they are facing, they have compliance issues they are facing, and then they have back end operational processing issues that they are facing. Thus, it's a longer, slow move, whereas when you move up to the biggest banks and you are talking about whether it be 100 or 300 or 500 or 2,000 ATMs, the benefits are pretty powerful and it has a skill set and competencies to integrate and move those, and they are expecting and are getting the kind of results that generate continue to rollout.

Thank you. That helps.

And we will go next to Michael Kim with Imperial.

Hi, good morning, guys. Just turning to electronic security, can you talk a little about some of the growth drivers in the quarter? Was it primarily a niche vertical or is there some initial extension to additional verticals and any commentary on the mix?

Yes, I would say that from the electronic security front it really was almost across the board at this point. We are putting more emphasis back on the financial side, but we still have a lot of pieces of business that extend beyond financial with electronic security. So I would say as we are building this organization out, our expectations are electronic security will continue to grow, physical security in this quarter was relatively flat, thus you saw the growth of electronic security evidence itself.

When physical security was down 10% or 20%, then you map any of the growth on the electronic side. So we've put resources against it, we think we have the right programs in place and the technical capabilities we are putting in place, and so our goal is to drive electronic security from a recurring revenue standpoint, which is different than some of the projects we've done in the past, which would be the one-time bigger installations or implementations and you get the product revenue but you don't get the ongoing recurring revenue.

And I would say that is the biggest difference for us is to focus on the recurring revenue streams. And while it is relatively small now, again, we expect this to grow over time and that's where we are putting our emphasis and focus, and our number one segment is going to be the financial segment.

And is most of the recurring revenue driven by IS or other monitoring-type revenue?

It would be a combination of those two -- IS and monitoring.

And what was the progress on any visibility on IS adoption at this point?

Yes, I am not sure I have -- we've got a couple of pretty good examples of mid-sized contracts, the $1 million to $2 million range with banks that have adopted IS really for us to take over some of the infrastructure for the security within those organizations, all the way up to some larger ones where they are going to be outsourcing; we're going to take over entire monitoring for them. So we are seeing a nice, wide range, but, again, we are starting out where the base is small and it will take some time to grow it.

Again, you are looking at a lot of these as these are monthly recurring revenue businesses, so you need to get a pretty big base before that monthly revenue and the margins associated with that are going to make the kind of impact we want. But we absolutely feel good about the pace and the direction we are on. We feel good about the ability that, as we focused on it, to see the early results that we are seeing.

Great, thank you very much.

And we will take our final question from Zahid Siddique with Gabelli & Company.

Hi, good morning.

Good morning.

A couple of quick questions. One of your competitors for the past several quarters has been commenting about gaining share in North American ATM market. I wanted to check with you to see if you have been losing any shares in North America over the past several quarters?

A couple things there. One is I would point -- the simple answer is no, we probably feel like we are the ones taking the share. When you look at our growth rate overall on a constant currency basis for the year in self-service, it's going to be 12% to 13%. I have not seen any competitor anywhere in the world talking at that level on a constant currency basis; that's number one. If I look at North America, I would look at the key components of North America.

The regional bank space were up 94%. I think the question earlier was indicating that some of our competitors are up 50% or somewhere in that range. So I look at that and say that we clearly are doing well in that regard. And then I would look at the other aspects of I think number of accounts and some other things like that where we feel like, again, we have a bigger share, we're growing faster, and have taken more accounts.

So I'm not sure how I can include anything that we are either holding or taking a little bit of share. But, again, on a quarter-to-quarter basis, I don't think that is as important as saying what are the fundamentals of business or what are we doing long-term systemically, and that's when we get into the integrated service and the service side of the business which we think again is our key differentiator, and that's why the customer accounts in the product is important to us.

It's really for the services and the add-on, recurring revenue of service. So I feel good about where we are at from a share standpoint. I certainly don't feel good where we are at in what we performed relative to a margin standpoint.

Okay. With regards to the Brazil tax assessment that you highlighted, if you take that and I guess also the FCPA and if you go back a few years, you had that revenue -- I think revenue recognition issue, why aren't these -- why do these issues keep on popping up in one shape or other? Is there something fundamentally wrong from there?

Zahid, this is Brad. I think they are very, very different issues. And, certainly, as I mentioned in my prepared remarks, you look at the investment we have made in the compliance area in order to really strengthen our global compliance and give ourselves confidence that in the areas, for example like FCPA, that we feel confident that we have got the controls in place to ensure we operate in conformance of the law.

I would point you to certainly in Brazil, the tax assessment that we got, and again, we take this very seriously, but I think you can look at Brazil and look at many multi-nationals and getting tax assessments is not uncommon. Again, we take this one very seriously, but it is not uncommon to get a tax assessment. But I think the issues we have had, they are not directly correlated. We invested very heavily in our compliance activity, as well as our control activity.

And then last question for security, you are guiding for full-year for revenues to be up 3% to 4%. I think that implies the Q4 would be up may be 11% or 12%, is that a fair assumption?

Yes.

I think that is pretty accurate.

And how much is electronic security within the security business?

It is generally about half. So, again, it depends on whether physical security is flat or down a little as to how it shakes out, but generally from an overall revenue standpoint, physical and electronics to date are 50/50 of the total security picture.

Thank you so much.

I wanted to turn the call back to you for any additional or closing remarks.

Thank you, Dana. Well, thank you, everyone, for joining us this morning and as always, if you have follow-up questions, please feel free to contact myself or Nick Codispoti directly after the call. Thanks.

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