Diebold Nixdorf Inc (DBD) 2014 Q2 法說會逐字稿

Good day, everyone. Welcome to the Diebold Inc.'s second-quarter 2014 financial results conference call. 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, Adam. Good morning and thank you for joining us today for Diebold's second-quarter conference call. Joining me today are Andy Mattes, President and CEO and Chris Chapman, Senior 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. Andy and Chris 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 are excluding certain restructuring charges and non-routine income and expenses from our non-GAAP financials. We believe that excluding these items gives an indication of the Company's baseline operational performance. As a result, many of the remarks this morning will focus on non-GAAP financial information. For a 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.

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 finally, a replay of this conference call will be available later today from our website. For those listening to the replay, please keep in mind that the information discussed is only current as of August 6, 2014 and subsequent events may render the information in this replay out of date. And now with opening remarks, I will turn it over to Andy.

Thanks, John. Good morning, everyone and thank you for joining the call today as we discuss our results for the second quarter. There are several items I will be covering today. First, I'll provide key takeaways from the quarter; second, a regional update; third, an update on our Diebold 2.0 turnaround strategy; and finally, our outlook for 2014.

Before I begin, I would like to recognize Chris Chapman who we recently named CFO. Most of you got to know Chris during his time as interim CFO. He did a great job in the interim role and of the dozens of candidates we have interviewed, the Board and I felt he was by far the best fit. Chris has a strong and unique skill set. With an in-depth knowledge of Diebold, he makes data-driven decisions with a global perspective and unwavering ethic. His promotion is an example of what we are trying to build from a talent perspective as we work to transform the Company. I am confident in his ability to continue to help lead Diebold toward a successful and sustainable transformation.

Now let's discuss these key takeaways from the quarter. We delivered strong performance with solid revenue growth, in line with our expectations, especially in EMEA where we continue to soundly execute on our focused account strategy. Our EMEA team continues to generate momentum and to increase our footprint. In our services business, we continued the positive performance trend of gross margin improvement as a result of our ongoing transformation efforts.

In addition to improved gross margin, the quarter benefited from higher net cost savings as the P&L impact of some of our reinvestments have shifted toward the second half of the year. As a result, earnings per share came in higher than anticipated.

Finally, I am encouraged with our order book as we are seeing positive growth in virtually every region across the globe and ended the quarter with strong backlog. This was driven primarily by a global strengthening of our core financial self-service business.

Looking at the full year, we are maintaining our revenue and earnings guidance. In the second half of 2014, as I mentioned earlier, we will be accelerating the pace of our investments in innovation, IT infrastructure, back-office transformation, service, sales and marketing. This will increase both our cost of sales and operating expense in the second half of the year. Chris will be covering this in more detail in his remarks.

We have been mindful as a company regarding the speed at which we ramp our investments as we want to have confidence that our cost savings are coming through at a rate that enables us to fund our reinvestments while delivering on our plan. Our focus remains on our four core pillars -- cost, cash, talent and growth and ultimately building a solid foundation for future profitable growth.

Now let's talk about order activity in our regions. Total orders for both product and services in the second quarter grew approximately 7%, or 9% on a constant currency basis, with growth in four of our five regions. When looking at total product orders, we grew 18% in the quarter or approximately 30% when excluding the Brazil other category, which was tied to a large IT-related order in the second quarter of 2013.

In North America, total orders during the quarter increased 7%. In financial self-services in North America, total orders, including services, increased 14% driven by strong product orders, which increased more than double that rate. As we previously indicated, the regional business in North America continues to steadily improve aided by a ramp of Windows 7 upgrades and branch transformation.

Our electronic security business in North America continues to grow with solid order activity. To help further grow our electronic security business, we continue to increase sales coverage by bringing experienced sales talent and leadership into the Company, having hired 35 of a planned 50 net new sales executives. We expect to hire the remaining sales leaders in the second half of 2014. However, as we've highlighted in the past, the mature physical security business continued to decline in the quarter, which more than offset the order growth in electronic security.

Moving to Asia-Pacific, total orders increased 22% for the quarter, or 29% on a constant currency basis, driven by strong growth in India and Southeast Asia. Our competitive position remains strong in this growing region. In EMEA, our team continues to execute operationally with total product and services orders growing 24% during the quarter and at a similar rate on a constant currency basis. We continue to see solid growth in Western Europe, as well as the Middle East and Africa.

In Latin America, total orders for the quarter increased 10% driven mainly by Mexico, adding to our improved backlog in the region. This positions us well for revenue growth in the second half of the year. In Brazil, orders for the quarter decreased 29%, or 23% on a constant currency basis. As we've communicated, year-over-year comps over the next several quarters will continue to be distorted by prior large orders in the Brazil other category. A similar effect will occur on the revenue side, which Chris will cover in his comments. Looking forward to 2015, Brazil will be a headwind as much of the noncore Brazil other business will not repeat.

Looking at our total business for the quarter, we continue our focus on becoming a services-led software-enabled company. Services and software revenue continued to make up the majority of our total revenue year to date at 57%.

Now let's discuss our Diebold 2.0 turnaround strategy and a few key initiatives as it relates to the eight-point program we previously outlined. First, in terms of establishing a competitive cost structure, we made good progress in our services margin as we are starting to improve our IT infrastructure. In the first half of 2014, we achieved a milestone in our IT transformation by sunsetting a number of 30-year-old IT apps to a more modern platform. Also, our new IT go-to-market model with Infosys successfully brought Brazil onto the Oracle platform as step one of our IT transformation. We still have a great deal of work in front of us as we overhaul our IT systems. Our CIO, David Ramsey and his team are off to a great start.

As it relates to our back-office transformation, you will recall that we announced our newly established Accenture relationship in Q2. We are early in the implementation phase and are in the process of transitioning a portion of the work scope. Our investments in this regard will ramp up in the second half of 2014. The full rollout of our partnership with Accenture will be a key focus area through 2015. In short, we are beginning to generate some positive traction and are building increased internal momentum as we begin to make progress on our transformation objectives.

Second, we drove a number of innovation customer solutions during the quarter. As part of Diebold 2.0, we said we would be investing in innovation and getting more of the behind-the-curtain technology out to the shop window. Along these lines, we introduced ActiveEdge last week, the first card-reading solution, which prevents all modern skimming devices from reading the card's full magnetic stripe by shifting a card's angle 90 degrees. Card skimming is the biggest ATM security risk facing consumers today and costs the industry more than $2 billion annually. We believe this innovative approach will be a gamechanger in the ongoing fight to protect consumer data.

In addition, we took meaningful steps to address security issues that have plagued the ATM industry for some time. For example, we are collaborating with Wincor to form the first ATM Security Industry Association to improve information-sharing across the ATM community on evolving attack methods. This represents an important step in the global effort towards ensuring ATMs remain a safe, secure option for consumers to confidently conduct financial transactions. We want to take this opportunity to encourage our colleagues within the ATM industry to join this important effort against global ATM crime.

Secured customer transactions are the foundation to a successful automated environment that is the center of the branch transformation value proposition. Along the lines of branch transformation, we continue to gain traction with a number of institutions striving to improve their branch operations and consumer capability. In addition to the work we continue to do with Bank of America, BNL and other global accounts, we are especially encouraged by the increase in branch transformation activity we are seeing in the regional bank space.

During the quarter, we announced a number of branch transformation projects with institutions such as Alpine Bank, Lakeland Bank and (inaudible) Credit Union. This demonstrates that our full breadth of branch transformation services and solutions are relevant to customers of all sizes.

Third, in regards to instilling a winning culture grounded in execution, we continue to focus on fostering a performance-based philosophy and bringing new talent into the Company to help drive change. Since the end of the first quarter, we attracted new leaders, including our heads of legal and compliance, global services and global marketing, as we continue to strengthen our leadership team and accelerate our transformation efforts.

Yesterday, we announced that Alan Kerr has joined the Company as our new head of global software. Alan brings extensive software experience to the Company, which will be critical as this element of our portfolio continues to grow in importance.

Finally, in regards to generating long-term profitable growth, we began by making some relatively small deals that support our Diebold 2.0 transformation and represent the types of opportunities we are evaluating to better align our portfolio with our longer-term strategy and view of the industry. We divested our Eras check and payment processing business and we announced our acquisition of Cryptera, a leading supplier of encrypting PIN pad technology. This approach supports our strategy to increase our intellectual property portfolio.

To conclude, we feel good about the progress we are making in our Diebold 2.0 transformation. However, we recognize that the majority of the heavy lifting remains in front of us as we are a company in transformation; we are [not] transformed. We are meeting our near-term objectives and remain confident in our long-term outlook. With that, I will turn the call over to Chris.

Thanks, Andy and good morning, everyone. I am very excited about my new role as CFO and I look forward to being a part of the new leadership team to drive the transformation of the Company. First, I will walk through our second-quarter financial performance. Then I will provide an update on our 2014 revenue, earnings and free cash flow outlook.

Now to review our financial results. Turning to slide 15, total revenue for the quarter increased approximately 4% or 6% on a constant currency basis as a result of increased volume in EMEA and Brazil, partially offset by a decline in Latin America and North America. We expect our non-core business in Brazil to be a strong contributor to our revenue growth for the full year. The currency impact was primarily driven by the Brazilian real and Indian rupee.

As we move to slide 16, financial self-service revenue was flat or up 2% on a constant currency basis with growth in EMEA offset by a decline in North America. As we have noted, EMEA continues to perform especially well posting solid revenue growth over the prior year. In North America, we had a tough compare in the national account business as a result of a large project with TD Bank in the prior-year period. However, as Andy noted, orders in North America were up significantly in the quarter, which positions us for a stronger second half of the year.

Total security revenue on slide 17 was up 2% compared with the prior-year period. Electronic security grew 15% driven by strong growth in North America. Offsetting this increase was a 14% decline in our physical security business.

Looking at slide 18, Brazil other was up $24 million, mostly driven by delivery on a large lottery order placed in the fourth quarter of 2013.

On slide 19, gross margin for the quarter improved 2.6 percentage points to 25.5%. This was driven by a solid improvement in service gross margin, which increased 6.5 percentage points to 30.8%. This improvement reflects the continued benefit of our service transformation efforts across the globe, including the ongoing benefit from our pension freeze and voluntary early retirement program in North America specifically.

In the second half of 2014, some of our reinvestments will impact service cost of sales as we focus on improving our systems and expanding our infrastructure to support our select geographic growth and our global service transformation efforts. Product gross margin decreased 2.2% percentage points to 18.7%. The decrease was a result of geographic mix primarily tied to higher volumes in emerging markets.

Moving on to slide 20, total operating expense increased $9.3 million. Operating expense as a percentage of revenue was 19.3% compared to 18.7% in the prior-year period. During the second quarter, increased volume drove higher selling expense as we continue to make investments in our transformation such as expanding our sales coverage in electronic security.

Turning to slide 21, year to date, we have realized approximately $20 million of our planned $25 million in net savings. To elaborate further, while our gross savings are relatively equally distributed over the quarters, the majority of our reinvestments will impact our P&L in the second half of the year. Over the mid to long term, these investments in innovation, IT infrastructure, back-office transformation, service, sales and marketing will continue to improve our internal controls and processes, reduce our costs and position us for growth.

Turning to slide 22, non-GAAP operating margin in the second quarter increased 1.9 percentage points to 6.2% as a result of increased volume and continued benefits of our transformation efforts. Looking at operating profit by segment, on slide 23, improvements in EMEA, North America and Brazil were partially offset by decreases in Asia-Pacific and Latin America. The increase in EMEA is a result of our historical restructuring efforts in the region coupled with strong growth. North America is directly related to the changes made to the cost structure. Asia-Pacific was impacted by country mix within the region. In Latin America, lower volume combined with the year-over-year comparison in Venezuela impacted operating profit.

EPS on a GAAP basis was $0.64 during the quarter. This includes restructuring charges of $0.01 primarily related to the multiyear realignment plan aimed at establishing a competitive cost structure throughout the organization. In addition, we incurred non-routine expense of $0.02 related to legal, indemnification and professional fees. The largest driver was non-routine income of $0.20 related to the Eras divestiture that we announced during the second quarter. The combination of these factors brings us to $0.47 earnings per share on a non-GAAP basis for the second quarter.

Our second-quarter non-GAAP effective tax rate was approximately 36% impacted by several discrete items. We are maintaining our approximate 30% non-GAAP effective tax rate assumption for the full year, but realize there could be upward pressure based on where we are at year to date.

Moving on to cash flow on slide 25, our free cash flow results reflect the $71 million free cash use, which increased approximately $30 million from the same period last year. This is a result of increased working capital needs as we have grown our business in the quarter and approximately $30 million in severance payments spread equally over the first half primarily related to the VERP. Partially offsetting these items was an improvement in net income.

Turning to slide 26, DSO during the quarter was 59 days, flat from the same period last year.

Looking at slide 27, inventory turns were down slightly at 4.6 turns compared to the second quarter 2013 of 4.9 turns as we built inventory to meet second-half deliveries. Net debt on slide 28 for the period was $178 million, a $21 million increase from the prior-year period, resulting in a net debt to capital ratio of 15%, an increase of approximately 3 percentage points.

Looking at our outlook on slide 29, the second quarter exceeded our internal expectations. We continue to be encouraged by the strong growth in orders in many of the regions driving increased order backlog. Additionally, as previously discussed, we will be ramping up our reinvestments in the business this year. Therefore, we are maintaining our revenue guidance to be up in the mid-single digits and non-GAAP EPS guidance of $1.65 to $1.85. As a reminder, this includes the adverse impact of the devaluation of the Venezuelan Bolivar of approximately $0.12 and an additional $0.03 related to the divestiture of Eras. The Cryptera acquisition is expected to be neutral to earnings after integration costs in 2014. We expect restructuring charges and non-routine expenses to be in the $0.25 to $0.30 range, excluding the $0.20 gain on the sale of the Eras subsidiary.

As previously highlighted, our full-year non-GAAP effective tax rate is expected to be approximately 30%, but we are seeing some upward pressure on the rate. We are maintaining our free cash flow outlook for the year of $80 million to $100 million. This includes an approximate $35 million increase in our capital expenditures as we make strategic reinvestments in our business.

In closing, we have started out the first half of the year stronger than expected focusing on continuous improvements to maintain and strengthen our control environment while operationally reducing our costs and improving our working capital efficiencies. We are actively working to remediate our material weaknesses in Brazil and India and have made solid progress, still expecting to have both remediated during the year. The Company is beginning to demonstrate tangible results from our turnaround efforts; however, it is still early in the process and we will fully ramp up the appropriate reinvestments in the second half to position the Company for long-term growth. With that, I will open up the call for questions.

(Operator Instructions). Paul Coster, JPMorgan.

Yes, thanks very much. A couple of things. Clearly, things have changed a little bit on the financial services front. It wasn't so long ago that you felt that branch transformation was still a little bit premature because the customers would take a while to benefit from the implementation of technology. They had, for instance, long leases that they couldn't break, but it sounds like things have changed. So I am just wondering why that is starting to power through and -- well, I will save my second question. Thank you.

Good morning, Paul. This is Andy. It's actually mapping out just like we told you. It is starting to pick up on the order side. Most of the activity and branch transformation is still in (inaudible), in showcase branches, branch of the future deployments of our key customers. So it is not that much of a revenue tailwind at this point in time, but we said at the last call that activity and conversations and Diebold mind share is increasing. That trend continues down that path. We start to see mind share now translating into orders, which eventually will translate, of course, into revenue. It is going to be a steady increase over the next years to come.

Okay, got it. Two quick questions. One is how long does it take for orders to translate into revenues generally for you by region? And one last question, which is, in the emerging markets, you clearly have low margins on the product sales there. Is there anything you can do to improve the margins in those regions for the hardware in particular?

Let me start on deal velocity. Apparently there is a wide range depending which country, which channel, whether they are services-led or whether they are more product shipments. If you were to draw a distribution curve, I'd say the majority of the deals probably revenue within a six-month time window, but some of them go as fast as three and others can drag out as long as 9 or 12 months.

Yes, on the cost side, Paul, where obviously we continue to look at everything we can do to maximize our cost from a supply chain standpoint, we look to localize as much as possible to eliminate currency risk. But I would say this is an area of constant focus for the Company as we look to improve on our long-term margin trajectory on the product side.

Thank you.

Gil Luria, Wedbush Securities.

Good morning. The Windows 7 upgrade seems to be kicking in in terms of creating a tailwind for you. What is the trajectory of that cycle? How many quarters do you expect that to last? When do you expect that to peak and why is it not translating into higher product margins for you? Are you capturing it more on the service line?

Gil, there's a few aspects. So first of all, the curve goes -- as we discussed earlier, we always said this would be more a second-half revenue event, so orders are coming in strong as we speak. The orders are going to revenue probably in the -- I would say the peak is going to be in the Q4, Q1-ish timeframe. You know that the Microsoft extended deadline runs out in April. I would expect some mad scramble from some customers to do it last minute and there you have got your revenue curve.

From a margin point of view, while these deals are very margin accretive, keep in mind that the relative size of the deal in comparison to everything else that we do in absolute numbers is a lot smaller. So the overall toll on the margins is somewhat muted by sheer size.

Got it. And then in terms of your Brazil business, could you help us separate kind of the three businesses there in terms of what is going on with the financial self-services versus the lottery versus the PC business? Is the PC business -- is that spike over and you will be comping it next year? Is the lottery business rolled out? Is it an unusually big year and then where are we on the ATM business?

Yes, Gil, just to break it down into the major pieces here, the PC/IT-related equipment, that really has peaked. There will be a small amount of activity in the third and fourth quarter, but not big numbers to come there. The biggest piece of the Brazil other is going to be in the lottery segment and expect the full year on that to be approximately $65 million to $70 million in total revenue on that with the larger portion coming through in the third quarter.

And then lastly when we look at the FSS business, we have talked about two really large deals that we have got that we have been delivering on. The first, which has been coming through the P&L here over the last several quarters, is with CEF, with Caixa Economica Federal and that will continue through the third quarter and really be wrapped up this year. The other large tender has been pushing out a little bit just as they finalize some of the branch deployment schedules and so expect that to really be -- really I would say pick up full speed in the fourth quarter and some of that carry into the first half of 2015.

Any other large ATM orders this year in Brazil that could fuel next year?

Nothing that we want to speak to at this time, but there is nothing significant on the radar screen. I would remind everyone, if you look at where you are at in Brazil with the large government banks and with elections coming up, that is really going to close down a lot of activity that we would typically see over the next couple of months and I don't expect that to really pick up really until after the elections and some of that gets settled out.

Got it. Thank you very much.

Matt Summerville, KeyBanc.

Thanks. A couple things. First, how much Brazil revenue and earnings goes away in 2015 relative to 2014 as you are looking at it at this point with respect to that other category?

Matt, I would just look really at the big PC sales we had in the first half, so call that approximately $90 million in revenue and look at the bulk of the lottery based on what we have in front of us right now and so probably about $50 million that falls out. So from a revenue standpoint, just at a high level comparing to 2015, I would say there's about $150 million that falls out. Obviously, it's still a lot to go in 2014 and we will see how all that activity plays out, but that is high level on the revenue side. And then apply approximately -- again, I don't have the exact numbers in front of me, but say a 10% to 15% margin pullthrough on that. That gives you rough order of magnitude.

Great, I appreciate the granularity there. And then second, just I want to talk a little bit about the tax strategy. The volatility in your non-GAAP rate over the last couple years is unlike any other name I follow. So can you go into a little more detail around the push and pull there and why or perhaps it's not, but why it should smooth out at some point here?

Matt, I am not going to go back through every year, but if you look at 2013 first, look at the size of our earnings and the distribution of our earnings. And I would say one of the keys to having a more stable rate is to have stable geographic revenue pullthrough and margin pullthrough and when you are in a transition and when you are going through some of the major items that we were facing in 2013, you saw some of that volatility in the rate.

And so when you look at the first half of 2014, the earnings are still relatively small. So if you have a one-off discrete item that comes through and/or a small shift in geographic income, which again as you understand not all revenue and profit is created equal when it comes to the tax impact on that. We still see a little bit of that volatility. Sitting where we are at today, we would typically want to narrow the range in the full year, but looking at where we have been out with the tax rate, it has caused a little bit of that volatility and we are doing everything we can to manage that and improve upon that and really, in my mind, that starts with improving the underlying fundamentals in all of our businesses, improving and having steady stabilized profit that is going to drive that in the future. But we are absolutely looking to manage that, provide appropriate clarity on what we see coming through and build that into the ranges that we are providing externally.

Great, and then just one quick follow-up. Andy, can you maybe talk about EMEA a little bit and what you attribute the recent success you have had there in terms of share gains, albeit off a lower base, but you are clearly gaining share in EMEA.

Well, Matt, Europe, for me, has been and continues to be the microcosm of what we want the big Diebold to be going forward. They were clearly a drag to the P&L a few years ago. They have gone through their restructuring efforts first, they have done their streamlining first and as part of that, we also stepped away from a thou must be in every country logic and focused on target accounts. And that strategy proved out to be extremely successful, so we are laser beam-focused on the large names in the UK, on the large names in Spain and in every one of those accounts where we focus our energy, we are starting to make very solid progress.

In addition, if you were to look at the research reports, you will see that, due to the absence of the equivalent of an ADA compliance ruling, especially in the UK, the UK probably has the most mature installed base of any country in the world. So this is a -- you have a pure technology upgrade cycle there, not superimposed by government regulations, add branch transformation and next-gen technology to it and all of a sudden the playing field gets releveled, which, of course, gives a Company like Diebold an opportunity to reenter and to show our innovative solutions and to take part in the race and so far with quite good starting positions.

I appreciate the color, Andy, Chris. Thank you.

Matt Lipton, Autonomous Research.

Hi, good morning. Thanks for taking my question. I think, Andy, it was really interesting to see what is happening with software and Diebold. You just hired the new head; it sounds like CapEx is increasing. So just curious if we can get some more thoughts on where that software spending is targeted. Is it the electronic security or more so the FSS? And as we think about branch transformation, these smarter ATMs that have more hardware functionality, how important is it that the software goes hand-in-hand with the machine and therefore, a bank might have to think about their conversation with Diebold a little differently than they have in the past?

Given my background, I still translate our industry back into IT speak and for me, an ATM in an IT world would be an appliance. It is a purpose-built hardware where the hardware continues to commoditize and to lose its factor as a differentiator. On top of the hardware, you have got a software stack sitting and the software stack continues to increase in importance and will, of course, drive the solutions and the user interface the security that we can offer to our clients. And then you add a very large services offering around it to make sure that you can take this technology to market. And that is why we are saying we want to be a services-led software-enabled company. That is why we are investing and Alan got a lot of the pedigree -- he's been in this environment, he's helped business transform from a hardware-centric to a more software-centric view and that was very appealing when we talked with him and I expect him to do similar work here at Diebold and help us to accelerate down that path.

And by the way, that logic is applicable to both FSS as well as electronic security. If you take a look at what we have done at electronic security, for instance on the secure stack side, which is software IP that differentiates Diebold, I mean we are pushing the 600 user mark as of the end of Q2 with very rapid growth rates and that will also be an area where we continue to invest.

That's great. Thanks. And then just curious if we get a little bit of an update on if you're having any more outsourcing discussions similar to what happened with TD a few years ago. It seems that there could be continued fee pressure on banks here from some potential rulings from regulatory bodies. Are you seeing an increase in inbound on outsourcing arrangements or really no update there? Thanks.

Think about it in all terms of moving up the stack on the services side. So professional services, managed services and then outsourcing, that can be partial outsourcing to all the way a full outsourcing. And I can tell you the amount of conversations we are having is increasing quarter over quarter over quarter. Now having said that, sales cycle in the services industry is anywhere between 12 to 24 months. These are not positions that either party would rush into. There is a lot of getting to know each other, making sure the business cases are accretive for both players, scenarios going on. So this is not a fast-moving part of the dial, but if I look at our newly rolled out salesforce.com pipeline portfolio, I can see our services offerings in the pipeline ramp up at a steady pace.

Great, thank you.

Justin Bergner, Gabelli & Co.

Good morning, Andy; good morning, Chris. My first question relates to working capital. I just wanted to dig in there a bit more. I notice that each of inventories and accounts receivable have sort of increased by about $100 million from the year-end number. I can sort of attribute a third of that to maybe perhaps below normal year-end levels and another third of that perhaps in accounts receivable to the large Brazilian sales and in the case of inventory to sort of preparing for what is normally a stronger second half. Is that the right way to look at the change in working capital and if so, sort of what explains the remainder of the increase?

You have the right pieces there. There is always going to be, on the AR side specifically, a little bit of that geographic mix. Payment terms aren't the same across all geographies, but when you look at the typical seasonal flow, you've hit the right points there. And again, we see a little bit of that build in receivables and if you look at Diebold historically and this industry historically, you will see a significant paydown on that as we ramp in the second and third quarter and ultimately peak with revenue in the fourth and those payments come down in the fourth.

The inventory again, you hit the right point there as well, the inventory is building, really driving the demand that we have here in the third and fourth quarter and so what you see right now is really the finished goods, which some of that is in-transit inventory and then the factory inventory as well is ramping up to again meet those second-half delivery needs.

Okay, great. But nothing sort of unusual, either accounts receivable or inventory fronts?

No, no. If you look at the DSO performance, it is in line with historical trends and nothing out of the ordinary there.

Okay, great. My second unrelated question, a bit different. If during your transformation Diebold were to receive sort of external interest in the Company perhaps by like a large software firm, how would Diebold treat such interest?

First of all, we take all conversations serious, whatever is being brought to us on any opportunity, but I'm not quite sure I am getting all of the angles that you are trying to get to.

If a large software company were interested in taking a look at acquiring a company like Diebold, I realize you are sort of in the early stages of your transformation, is the Company focused on completing the multiyear transformation or would potential external interest be seriously considered at this point?

Well, Justin, that's an easy thing. My job is to drive the turnaround of the Company together with Chris and the complete management team and to make sure we satisfy our customers, our shareholders, as well as ultimately all the people that work for us. Now if in that process at any given point of time someone thinks that we might be a good add to their portfolio, I have a fiduciary responsibility to take any of those conversations, A, serious and if it's meaningful and mindful to the Board and we will take it from there.

Okay, fantastic. I appreciate that.

Jeff Kessler, Imperial Capital.

Thank you, thank you for taking my question. First, can we just drill down a little bit more on EMEA? You've talked about the UK and you've talked about Spain and actually the way it fits perfectly into your restructuring plans. Can you expand that to some of the other strong areas that you've had in EMEA? You've particularly mentioned earlier on some of the Gulf States and I am just wondering how it's still small, but can EMEA become the size of let's say Asia-Pacific given how young or in some sense, excuse me, how old some of the stuff is in EMEA. Isn't there a lot of opportunity relative to perhaps a couple of the other regions that you have for a total change given that there is potential for a total changeout?

Jeff, those are all good questions and I think you are on the right track here. First of all, we feel very good about the momentum that we have established. If you look at EMEA, our focus clearly is Western Europe. It is the Middle East, we have got some nice orders, especially from Saudi, in the first half of the year, as well as Africa and South Africa has been a Diebold stronghold and it continues to do so. And there is also an opportunity as the South African banks go north to go with them. Now we will continue to invest, especially in the Middle East and Africa region. If you go back, the gentleman that we've asked to lead our EMEA operations, Bassem, he actually has this as his background in his past. So that was a very deliberate choice to make sure we get some more local expertise onto the European team and we will continue to be very account-centric about our growth going forward and making sure we do this in a profitable, digestible and also in a very ethical way going forward, especially as we reach out into the African nations.

Okay, because obviously country by country there is going to be countries in Europe where either regulations or just the way you do business or local competition is going to make it hard for you to really become profitable unless you lower prices. I am assuming that you are just going to focus on those countries where you have the best opportunity.

You see, Jeff, the good news is, when you grow from a small base, I don't have to defend a position in any given market. We will be very smart about target identification and where we are going and we will continue down that path. Our objective, not just for Europe, but for around the globe, is profitable growth. We never go for revenue for revenue's sake; we are going for opportunities that make good business sense either in the near term or in the mid-term over the life of the contract.

Okay. A quick second follow-up question on the software side. You've talked about the increased use of essentially putting the stack on top of the appliance and then adding services around that. When you look at the electronic security side of the business, you've got a secure stack platform that has been set up. Is there the capability ultimately of integrating some of the security software capabilities that you have on the electronic security side with the financial side or are they going to continue simply to go their separate ways given the fact that you do want to become more broad-based? On the other hand, you seem to have the capability at this point in time to integrate some of the platform capabilities from both sides to bring to bear on the financial area that is still 50% of your business in security?

You must have been sitting in one of our conference rooms, Jeff.

Well, do you want to hire me as a consultant? I'll do it.

Cross-pollination between those two areas is one of the most heavily discussed and investigated topics we have within Diebold. You can even attribute part of our service gross margin improvement to that fact as outside of the large metropolitan areas in the US where we've gotten really good and really smart at cross-training and cross-utilizing service technicians. So while secure stack the way it is written would not lend itself to run as an app on an ATM, the logic behind it, the thought process behind it is very much applicable and we do a lot of intellectual learning from one side of the house to the other.

The other thing that we start to see, especially as we get into the branch transformation environment, consumer retail is usually a little bit more innovative and a little ahead on the use of technology curve versus retail banking. So in many cases, there are use cases that we see, for instance, on the consumer side, on the retail side of electronic security that we are actually bringing to the financial institutions by saying you might want to take a look at what so-and-so does in the following industry because it is actually addressing a similar problem that you want to do with your branch of the future and you might benefit from that.

So a lot of conversations going on. This is why we are excited on having both pieces of the business in our portfolio and we will continue to invest into both sides of the house.

Yes, and I am assuming this also involves taking unstructured and structured data and trying to make sense of it for both sides, both your financial, your retail -- and retail folks?

Absolutely.

Okay, all right, thank you very much.

Meghna Ladha, Susquehanna.

Thank you. Most of my questions have been answered. Just two quick questions for Chris. Chris, Brazil other segment, the revenue came in well above our estimates this quarter. I may have missed this, but can you give more color as to what drove the upside there this quarter and how we should think about growth in the second half?

In the quarter, about two-thirds of the revenue in Brazil other was attributed to the lottery and again, we announced that order I believe in the fourth quarter of 2013. And so it was the initial deliveries on that order that drove the biggest piece. And what was your follow-up question with regard to the full year?

Yes, how should we think about growth in the second half, yes?

Yes, the second half in the Brazil other -- again, I think the total overall lottery right now I would estimate to be around $65 million for the full year and probably another roughly $15 million, $20 million coming through on the IT-related equipment side and that would be the biggest piece as we would see it right now. It is going to tail off over the next couple of quarters based on what we can see right now.

Got it. And then given that you are reinvesting more in the business in the second half, how should we think about the EPS progression next couple of quarters?

I would say the reinvestments right now, I would say they will peak a little bit more in the fourth quarter based on what we are seeing. And so it is going to increase here over the next couple of months. So again, as we talked about, the savings are fairly equally distributed over the quarters and the reinvest is going to ramp and so I would think about it in those terms.

Got it. Thank you.

(Operator Instructions). Paul Coster, JPMorgan.

Thanks for taking my follow-up. I appreciate that you are reinvesting in the second half and I can see why that would cause operating expenses to increase a tad, but what I didn't quite get was your comment around increasing cost of goods sold. I may have misheard. Can you just sort of revisit that? It was in your opening remarks, Andy.

Let me start and Chris will take you through the numbers. But if you look at the areas where we are investing, there are two main items in there. Especially it's the IT transformation. It's also of course the back-office transformation as part of our foundational work for our service transformation and these areas do not only show up on the OpEx side of the house if actions are service-related, if we are introducing service software and we have said publicly a few months back that one of the elements of our IT turnaround is that we are going to upgrade the Company to Diebold for services. These are discrete investments and those will be running through the P&L on the cost-of-sales line versus the OpEx line.

And just to add to what Andy talked about, in addition to that, on the service cost-of-sales area, where we are seeing growth in some of the markets, we are going to have to expand our overall service infrastructure and service organization, so you will see some of that come through in those regards with the additional service cost of sales.

Okay, got it. Thank you. That makes sense.

We have no further questions in our queue at this time.

Thank you, Adam. I'd like to thank everyone for joining us on the call this morning and before we go, just one final announcement. We will be holding our annual Investor Day on December 10 in New York City, so please look for a save-the-date email in the coming weeks. As always, if you have follow-up questions, please reach out to myself or Jamie Finefrock directly. Thanks again.

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