http://www.ohio.com/business/52432277.html

 

Diebold second-quarter earnings up; outlook toned down

 

By Jim Mackinnon

Beacon Journal business writer

 

POSTED: 10:16 a.m. EDT, Aug 04, 2009

 

Diebold Inc. made a better-than-expected profit for the second quarter, but ratcheted down slightly its earnings outlook for the year.

 

The Green company, which makes automated teller machines and is expanding its financial services business, made $30.6 million, or 46 cents a share, on revenue of $700.5 million for the quarter ending June 30. Income was up 5 percent from a year ago, when it reported making $27.2 million, or 41 cents per share. Revenue was down 9 percent from the second quarter of 2008.

 

‘‘. . . There are signs that the market has bottomed out and is beginning to stabilize,’’ Tom Swidarski, president and chief executive officer, said in a prepared statement. ‘‘For the remainder of this year, however, we don't expect any significant rebound in demand as spending remains tight with our financial customers.’’

 

Industry analysts had expected Diebold to report making 33 cents per share. Revenue, while down from a year ago, also exceeded consensus expectations.

 

Shares rose 9.9 percent, or $2.82, to $31.19 as of 11:35 a.m. Shares are up 13.4 percent, including reinvested dividends, as of Jan. 1 and are down 11.7 percent from a year ago.

 

Diebold said it expects to make $1.34 to $1.52 per share based on generally accepted accounting principles, or $1.70 to $1.90 on a non-GAAP basis. Diebold previously said it expected to make $1.33 to $1.60 a share, or between $1.70 and $2 on a non-GAAP basis.

 

In addition to making ATMs, Diebold also makes security systems and electronic voting machines, and is changing to provide a higher emphasis on providing services to the banking and financial services industries.

 

‘‘In light of the rapid changes taking place in the financial industry, we must continue to assess our operations,’’ Swidarski said. ‘‘As such, we continue to evaluate our manufacturing footprint, our current lines of business and our go-to-market strategies to strengthen our competitive position moving forward.’’

 

Diebold Inc. made a better-than-expected profit for the second quarter, but ratcheted down slightly its earnings outlook for the year.

 

The Green company, which makes automated teller machines and is expanding its financial services business, made $30.6 million, or 46 cents a share, on revenue of $700.5 million for the quarter ending June 30. Income was up 5 percent from a year ago, when it reported making $27.2 million, or 41 cents per share. Revenue was down 9 percent from the second quarter of 2008.

 

‘‘. . . There are signs that the market has bottomed out and is beginning to stabilize,’’ Tom Swidarski, president and chief executive officer, said in a prepared statement. ‘‘For the remainder of this year, however, we don't expect any significant rebound in demand as spending remains tight with our financial customers.’’

 

Industry analysts had expected Diebold to report making 33 cents per share. Revenue, while down from a year ago, also exceeded consensus expectations.

 

Shares rose 9.9 percent, or $2.82, to $31.19 as of 11:35 a.m. Shares are up 13.4 percent, including reinvested dividends, as of Jan. 1 and are down 11.7 percent from a year ago.

 

Diebold said it expects to make $1.34 to $1.52 per share based on generally accepted accounting principles, or $1.70 to $1.90 on a non-GAAP basis. Diebold previously said it expected to make $1.33 to $1.60 a share, or between $1.70 and $2 on a non-GAAP basis.

 

In addition to making ATMs, Diebold also makes security systems and electronic voting machines, and is changing to provide a higher emphasis on providing services to the banking and financial services industries.

 

‘‘In light of the rapid changes taking place in the financial industry, we must continue to assess our operations,’’ Swidarski said. ‘‘As such, we continue to evaluate our manufacturing footprint, our current lines of business and our go-to-market strategies to strengthen our competitive position moving forward.’’

 

 

In the transcript below, note especially:

 

Page 3

Our second-quarter security revenue decreased $39 million or 20%. Security revenue continues to be adversely affected by significant weakness in the U.S. financial markets, mainly in the regional bank segment. However, we expect some recovery in the national bank area in the second half of the year, as we complete a major security upgrade for one of our large customers.

 

In the retail and commercial space, while spending remains weak, we did see sequential improvement in the business from the first quarter. Our government security business decreased during the quarter, as we saw some delays in project implementation. Finally, election systems revenue was down $17.5 million or 65% in the second quarter of 2009. [This implies that Diebold's election systems revenue was just under $27 million in the first quarter of 2009.  Decreasing by 65% would indicate $9.4 million in revenue for election systems in the second quarter.]

 

Page 4

Turning to our full-year outlook for 2009, as Tom mentioned in his remarks, we continue to experience a tough environment with our poor financial markets. This is having a strong negative effect on our security business. As a consequence, we now expect security revenue to decline in the range of 11% to 19%. Revenue expectations in total for the other segments remain essentially unchanged. We expect total revenue to decline 7% to 13%, with currency headwind of about 3%. Financial self-service revenue is expected to decline 2% to 8%. Lastly, we expect election systems revenue of $40 million to $50 million, with no anticipated elections revenue from Brazil and lottery systems revenue of $5 million to $10 million.

...

Also, as disclosed in the first quarter, we have reached an agreement in principle with the staff of the SEC on settlement terms. The settlement process is ongoing and remains subject to the final approval of the SEC. There can be no assurance that the SEC will accept the terms of the settlement negotiated with the staff, and we can’t speculate on the length of time it will take to reach a final agreement with the SEC.

 

 

 

http://seekingalpha.com/article/153720-diebold-incorporated-q2-2009-earnings-call-transcript?page=1

 

Diebold, Incorporated Q2 2009 Earnings Call Transcript

August 04, 2009

 

 

Diebold, Incorporated (DBD)

Q2 2009 Earnings Call Transcript

August 4, 2009 10:00 am ET

 

Executives

John Kristoff -- VP and Chief Communications Officer

Tom Swidarski -- President and CEO

Leslie Pierce -- VP, Interim CFO and Corporate Controller

 

Analysts

Kartik Mehta -- Northcoast Research

Matt Summerville -- KeyBanc

Reik Read -- Robert Baird & Company

Gil Luria -- Wedbush

Zahid Siddique -- Gabelli & Company

Edward Wheeler -- Buckingham Research

 

Presentation

 

Operator

 

Good day, everybody; and welcome to the Diebold Incorporated second 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.

 

John Kristoff

 

Thank you, Bill. Good morning, everyone; and thank you for joining us for Diebold's second-quarter conference call.

 

Joining me today are Tom Swidarski, President and Chief Executive Officer; and Leslie Pierce, our Corporate Controller and Interim Chief Financial Officer.

 

Just a few notes before we get started. In addition to the earnings release, we have provided a supplementary presentation on the Investor page of our website. Tom and Leslie will be walking through this presentation as part of their comments today, and we would encourage you to follow along.

 

We have also included non-GAAP financial measures throughout our presentation this morning. Specifically, I refer you to slides 24 through 34, which provide our rationale for the use of non-GAAP measures, as well GAAP to non-GAAP reconciliations.

 

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, and as a precaution, we refer you to the more detailed risk factors that have previously been filed with the SEC.

 

And now, with opening remarks, I'll turn it over to Tom.

 

Tom Swidarski

 

Thanks, John. Good morning, everyone.

 

Let me begin by saying I am pleased with our performance in the second quarter. We outperformed our internal earnings projections, we continue to make progress in lowering our overall cost structure, and stayed on track with our Smart Business 200 cost reduction initiative.

 

We generated our eighth consecutive quarter of year-over-year improved service gross margins and achieved the highest quarterly service gross margin in nearly 6 years. We also made further progress in working capital management. We generated significant free cash flow and improved our net debt position. Our strong balance sheet and liquidity continues to be a particularly important quality in this environment.

 

While we performed very well in the second quarter, the economic conditions of our core markets in the financial industry continues to create a challenging environment. As I mentioned during the first quarter call, we began to see signs that the market was bottoming out and beginning to stabilize. In the second quarter, our observations were confirmed, as we have seen further evidence of market stabilization. Spending levels, however, remained well below normal, particularly in Europe and in the U.S. regional bank space, and we don't expect a significant rebound of demand for the remainder of the year in these markets. To reflect this expectation, we're tightening the top end of our guidance range for 2009.

 

Over the next several minutes, Les and I will discuss our business performance, walk you through the latest developments we are seeing in our markets, and provide an update on our strategic initiatives.

 

First, let us walk through our second quarter results.

 

We continue to improve our gross margins in the service business, despite lower revenue and a difficult business environment. In addition, we experienced stronger-than-expected performance in our Asia-Pacific business unit. Our net cash from operations increased about $70 million, despite a year-over-year decrease in revenues. Second-quarter free cash flow was more than $50 million, and we significantly improved our net debt position.

 

Looking at financial self-service performance during the quarter, let us first turn to the Americas. As in the first quarter, the large banks in the United States continued their brisk pace in deploying deposit automation. The longer-term nature of their planning cycles allows us better visibility into this segment. Through the remainder of the year, we see large banks continuing to deploy financial self-service technology, particularly in the area of deposit automation.

 

Along these lines, in June, we launched our enhanced note acceptor or ENA, which accepts mixed denomination deposits of up to 50 notes, without using an envelope. During the development process, we leveraged our strong deposit automation experience and technology expertise to design ENA to deliver simplified servicing, ease of operation, and superior reliability. Our in-house design is a direct result of input from our customers, our own service technicians, and our cash handling partners to ensure the greatest ROI possible.

 

The ENA, paired with our bulk check acceptance module, has the ability to process cash and checks simultaneously, providing consumers with the fastest, most dependable automated deposit experience available. Our rapid processing feature is not offered by any competitor in the industry, and continues our competitive edge in developing innovative technology. This successful development effort underlines the importance of investing in new solutions that create sustainable competitive advantage. These development investments remain critical, even as we streamline our business and aggressively attack our cost structure.

 

While deposit automation deployment continued in the US national bank segment during the quarter, activity in the regional bank segment remained very weak. However, we have seen the depressed level of demand in this area begin to stabilize, unlike in the first quarter, when demand weakened sharply. In addition, anecdotally, we are seeing more activity in terms of RFPs and interest during the quarter. While we view this as an encouraging development, the sales cycle seems to be lengthening somewhat and we have not seen any pickup in our order book.

 

As we outlined in the first quarter, there are several catalysts driving the weakness in the US regional bank segment. First, the deployment of capital remains extremely conservative in this space, especially in light of recent fears of increasing consumer credit default and the FDIC’s recent estimate of up to 500 bank failures.

 

Secondly, the pipeline for new branch openings remains depressed, with levels at approximately half of what we have seen over the past several years. We don't anticipate this will change in the near future.

 

Lastly, the special assessment levied by the FDIC was finalized at five basis points that is recorded June 30 and payable September 30. While this results on the uncertainty around this issue, it still represents an unbudgeted expense that must be funded from other areas, such as capital investment. In addition, the FDIC left open the possibility of further assessments if needed.

 

As these issues continue to impact spending in the regional bank space, we believe this will continue to adversely affect demand for the remainder of the year. We still believe, however, that the constrained capital environment creates further opportunities to grow our integrated services business. By outsourcing various non-co-operational functions to Diebold, such as ATM networks, security, and other related operations, our customers are able to conserve capital, while lowering operating expenses.

 

In Latin America, we had strong revenue growth during the quarter. This was driven by Brazil, where we remain the clear market leader and continue to build on the momentum of the major orders we received last year. Our superior service operations remains the key to our competitive advantage in the Americas, as well as other regions. During the second quarter, we continued to make strides in all levels of performance, including response time, call rates, fixed rate the first time, and customer satisfaction scores. As I mentioned earlier, this outstanding performance led to our eighth consecutive quarter of year-over-year service gross margin improvement.

 

So, looking at the Americas as a whole, our service operations remain critical to our success, and represent the heart of our competitive advantage. A comprehensive services portfolio is highly valuable, difficult to duplicate, and is a foundation upon which we will build and evolve our business moving forward.

 

Now, turning to EMEA. We continued to see severe economic turmoil in Russia and Eastern Europe, resulting in significantly lower production levels in our Budapest, Hungary manufacturing facility. This created a significant loss of absorption, and was a primary factor in erosion of product gross margins during the quarter. In addition, order activity remains extremely low, as we had anticipated in our prior guidance. We don't expect any significant improvement in this region through the end of the year.

 

In Western Europe, we have seen some of the same economic challenges as in the United States. While business in this region is relatively strong, it has not been impacted nearly as negatively as Eastern Europe. We continue to focus on strengthening our competitive position within major markets where we have a significant presence, such as France, Italy, and Belgium.

 

In Asia-Pacific, our second-quarter performance was stronger than expected, led by China, and was the primary reason we exceeded our internal quarterly EPS projection. Second-quarter financial self-service revenues grew in the Asia-Pacific region. This is particularly impressive against the difficult comparison to the prior period, as banks in China deployed ATMs in advance of the Beijing Olympics. We are now seeing a similar pattern to 2008, where ATM deployment in China is shaping up to be more front-end loaded than in past years. Overall demand in the region remained strong, with orders up more than 50% during the second quarter. This performance was driven by China, Thailand, and India.

 

Now, looking at our security business. We continue to see new branch construction at about 50% of recent levels and facility renovations continue to occur at lower levels than in previous years. These factors, in addition to depressed capital spending in the U.S. regional bank space are having a profoundly negative effect on our recent performance in security.

 

In the government market, we have seen some push out in various planned projects. In regard to the United States Postal Service security system implementation, we have experienced some IT related delays on the customer’s end. This resulted in lower than expected revenue in the quarter. These delays have been largely resolved and the project is now progressing.

 

In the commercial side of the business, we are beginning to see increased order activity as some major projects are beginning to move forward. As I mentioned during the first quarter call, we have put new leadership in place for the security division with Brad Stephenson. Looking forward, he and his team are working to drive improvements in operations, and leverage our expertise to capitalizing security needs within the financial industry, outside of the traditional bank branch. This represents an opportunity to provide our solutions and services in our core markets that frankly, we haven't focused on in the past. With our relatively new capability in enterprise security, as well as our growing integrated services security business, we have additional competencies we can leverage with our traditional customer base. Brad will discuss this opportunity in more detail during our analyst event in September.

 

From an operational perspective, Brad and his team are evaluating the organizational structure, examining our complete solutions set, including what we manufacture versus what we source, and assessing our sales and distribution model. The financial industry is changing rapidly, and we must transform our organization and strategies to position ourselves for future success.

 

Across the global enterprise, we continue to make solid progress on a number of fronts. I am pleased with the progress of our Smart Business 200 cost reduction initiative. We remain on track to achieve our savings target of $30 million to $35 million in 2009, as we continue to make strides to lower our overall cost structure. We also continue to make progress in working capital management, as demonstrated by our significant improvement in net debt and free cash flow. And as I mentioned earlier, our intense focus on the services business has resulted in further improvements, both in customer satisfaction, and in service gross margins.

 

In light of the rapid changes taking place in the financial industry, we must continue to access our operations, global manufacturing footprint, and our sales and distribution model to strengthen our competitive position moving forward. From a corporate leadership perspective, our search for a new CFO is progressing, as we have interviewed a number of strong candidates. I am pleased with our progress thus far and the quality of people we have identified to potentially fill this role.

 

In summary, our outlook for financial self-service market remains essentially unchanged. We continue to face a challenging environment, particularly in Europe and the U.S. regional bank segment. However, we continue to see signs the market is stabilizing in these areas. Despite global challenges, the Asia-Pacific and Brazilian markets continue to generate substantial growth. Conversely, our security business continues to be disproportionately affected by the reduction of capital investment in the regional bank space. As a result, we have reduced our revenue outlook for the security business and have tightened our EPS guidance on the top end of the range.

 

While our operational improvements remain on track, we realize we must continually evolve, given the ever-changing landscape. Our focus is to manage the business as lean and effectively as possible, without sacrificing our investments in services and R&D. This will enable us to be in a stronger competitive position once the market improves. From a market perspective, we will continue to develop and enhance our industry-leading deposit automation portfolio. Likewise, we will maintain a laser focus on growing our services capabilities, which remain a key to our future success.

 

Finally, we continue to build on our strong balance sheet and liquidity position, and remain focused on positive working capital management.

 

As always, I am very proud of the effort and knowledge our global associates bring to work everyday. The innovative solutions and the value that we provide our customers and shareholders are evident across the markets we serve. At the end of the day, this company is about its people. We have asked them to make a number of sacrifices in the midst of the numerous challenges we have recently faced, and we have worked hard to provide them with the stability and continuity in this difficult economic environment. Their dedication and integrity form the foundation on which we will continue to build upon our 150 years of success.

 

With that, I will turn the call over to Leslie.

 

Leslie Pierce

 

Thanks, Tom, and good morning everyone. Before we discuss our second quarter financial results, it is important to note that we have restructuring charges, non-routine income and expenses, as well as impairment charges in our financial results. We believe that excluding these items gives an indication of the company’s baseline performance. As a result, many of my remarks will focus on non-GAAP financial information. For a reconciliation of our GAAP to non-GAAP numbers, please refer to slide 24 to 34 in the supplemental material provided on our website.

 

Now let us turn to our financial results. First, I would like to refer to slide 12, which focuses on the second quarter revenue highlights. Total revenue decreased $68 million or 9% in the second quarter, which included a net negative currency impact of 5%. You will note that service revenue decreased slightly more than product. This was primarily the result of a large government-owned bank customer in Brazil making a strategic decision to bring the management of its ATM network operations back in-house. Previously, these operations had been outsourced to Diebold.

 

Looking at our financial self-service business on slide 13, revenues decreased $13 million or 2% in the second quarter. The decrease was attributable to negative currency impacts of 7%. Excluding currency impact, financial self-service revenue grew 5% in the quarter and 7% year-to-date, driven by growth in Asia Pacific, Brazil, and the US national bank segment. These gains were partially offset by lower revenue from the US regional bank segment and from EMEA, mainly in Russia and Eastern Europe.

 

On a constant currency basis, Asia-Pacific revenue grew 13%, despite a difficult comparison to an especially strong second quarter in 2008. Once again, Asia-Pacific significantly exceeded our expectations during the period. We had anticipated returning to a more typical revenue seasonality within Asia-Pacific in 2009. However, it is trending toward a similar pattern as in 2008, with revenue being more front-end loaded than the historic norm.

 

Now turning to slide 14. Our second-quarter security revenue decreased $39 million or 20%. Security revenue continues to be adversely affected by significant weakness in the U.S. financial markets, mainly in the regional bank segment. However, we expect some recovery in the national bank area in the second half of the year, as we complete a major security upgrade for one of our large customers.

 

In the retail and commercial space, while spending remains weak, we did see sequential improvement in the business from the first quarter. Our government security business decreased during the quarter, as we saw some delays in project implementation. Finally, election systems revenue was down $17.5 million or 65% in the second quarter of 2009.

 

Turning next to non-GAAP total gross margin, refer to slide 15. In the second quarter of 2009, total gross margin was 25%, down from 26.1% in Q2 2008. Product gross margin in Q2 2009 declined 3.2 percentage points. This reduction was the result of unfavorable mix, primarily within the U.S. financial segment, where we saw lower revenue in the more profitable regional bank segment and higher revenue in the national bank segment during the period.

 

In addition, lower production levels, mainly in Europe, also adversely affected quarter-over-quarter manufacturing absorption. The mix shift in lower overall revenue more than offset the benefit from cost savings initiatives. Conversely, service gross margin in the second quarter of 2009 improved 0.8 percentage points to 25.5%. This represents the highest quarterly service gross margin we have reported in nearly six years. This improvement came despite lower revenues and was driven by productivity gains, which we expect will drive continued margin improvement through the balance of the year.

 

Moving now to non-GAAP operating expense. As highlighted on slide 16, in Q2 2009, operating expense, as a percent of revenue was 18.3%, compared with 17.4% in the comparable period of 2008. On a dollar basis, however, operating expense decreased more than $5 million compared with the second quarter of 2008. It is important to note that despite the drop in revenue, we are maintaining our current levels of investment in R&D and our IT infrastructure.

 

On a year-to-date basis, operating expenses decreased approximately $20 million and improved 0.2 percentage points. SG&A expense is down across most regions, and we continue to focus on managing operating costs.

 

Now if you would return to slide 17, non-GAAP operating profit margin in the second quarter of 2009 was 6.7%, compared to 8.7% in the second quarter of 2008. This decrease was due to the decline in product gross margins noted earlier, as well as negative leveraging of operating expenses on declining revenue. On a year-to-date basis, operating profit as a percent of net sales was 5.9%, compared to 7.2% for 2008.

 

Turning to the EPS reconciliation on slide 18, non-GAAP EPS from continuing operations in the second quarter was $0.49, compared with $0.69 in the second quarter of 2008. Despite this decrease, second-quarter EPS was stronger than we anticipated, largely due to results in Asia-Pacific. As I mentioned earlier, we had anticipated a return to typical seasonality in this region for 2009, but instead, are seeing a more front-end loaded spending pattern similar to 2008.

 

Turning next to free cash flow on slide 19. I was pleased with our second-quarter performance of free cash flow, which we define as net cash from operating activities less capital expenditures. Free cash flow in the second quarter was $50.7 million, an increase of $58 million from the second quarter 2008. This improvement was mainly attributable to the progress we have made in our working capital mix, which we will cover on the next two slides.

 

On slide 20, day sales outstanding or DSO improved by 11 days, moving from 59 days at June 30, 2008 to 48 days at June 30, 2009. We view DSO as a leading indicator of performance and are pleased that we are able to continue to build upon the gains we have already made. Inventory turns improved from 3.9 turns at June 30, 2008, to 4.3 turns at June 30, 2009.

 

Turning next to liquidity and net debt, net debt at June 30, 2009 was $238 million, a decrease of about $134 million from June 30, 2008. Our net debt-to-capital ratio was 19% at June 30, 2009, compared to 24% at June 30, 2008. During these challenging economic times, we continue to exercise discipline in maintaining a strong balance sheet.

 

As some of you are aware, our credit facility is due to expire in April 2010. During the quarter, we began discussing the renewal with our creditor bank. These discussions are going well and we are on track to finalize the renewal in 2009. The bank group continues to express support in meeting our credit needs. We believe that our financial position and strong relationships with the group should help facilitate the renewal process.

 

Since the current credit facility expires in less than one year, the outstanding balance on the company's facility has been reclassified from long-term notes payable to short-term notes payable. The company plans to reclassify the balance back to long term notes payable upon completion of the renewal process.

 

Lastly, with a dramatic change in the credit market since our last renewal, we anticipate a significant increase in the interest rate spread from our current rate of 50 basis points over LIBOR.

 

Turning to our full-year outlook for 2009, as Tom mentioned in his remarks, we continue to experience a tough environment with our poor financial markets. This is having a strong negative effect on our security business. As a consequence, we now expect security revenue to decline in the range of 11% to 19%. Revenue expectations in total for the other segments remain essentially unchanged. We expect total revenue to decline 7% to 13%, with currency headwind of about 3%. Financial self-service revenue is expected to decline 2% to 8%. Lastly, we expect election systems revenue of $40 million to $50 million, with no anticipated elections revenue from Brazil and lottery systems revenue of $5 million to $10 million.

 

We now expect our full-year 2009 GAAP EPS to be in the range of $1.34 to $1.52. Excluding restructuring and non-routine expenses and income, non-GAAP EPS is expected to be in the range of $1.70 to $1.90.

 

Also, as disclosed in the first quarter, we have reached an agreement in principle with the staff of the SEC on settlement terms. The settlement process is ongoing and remains subject to the final approval of the SEC. There can be no assurance that the SEC will accept the terms of the settlement negotiated with the staff, and we can’t speculate on the length of time it will take to reach a final agreement with the SEC.

 

We remain committed to improving our financial control systems, processes and procedures, with proper controls that drive efficiency, accuracy, and timeliness in our accounting financial reporting. We continue to address our remaining material weaknesses aggressively. Through the second quarter, we remediated three of the six material weaknesses that were identified as part of the restatement process, and we have made significant progress on our fourth weakness. We remain on track to have all six remediated by the end of this year.

 

In conclusion, we continue to focus on managing our costs, gaining efficiency, and maintaining our strong balance sheet and cash flow, as we manage the business in this challenging environment. We also realize the strategic benefit of maintaining our current investment level in R&D and IT infrastructure, which will enhance our competitive position when market conditions improve.

 

Finally, as Tom noted, we continue to focus on our service business, both in terms of profitability improvement, as well as investing in future growth opportunities, such as our integrated services business. We remain confident in our ability to weather these difficult times and emerge a stronger player in this changing environment.

 

Now I will turn the call back to John.

 

John Kristoff

 

Thank you, Leslie. Bill, can we open it up for questions now, please?

 

Question-and-Answer Session

 

Operator

 

Thank you. (Operator instructions) We will take our first question from Kartik Mehta at Northcoast Research.

 

Kartik Mehta -- Northcoast Research

 

Hi, Tom, good morning. I wanted to ask you a little bit about the recent BofA announcement and how that might impact your business and I'm talking about the potential branch reductions that BofA is thinking about.

 

Tom Swidarski

 

What we have heard, Kartik, in terms of the communication they had in the -- I think the American Banker, from our perspective, we work -- obviously, we are fortunate enough to work very closely with those guys and they have been very consistent in their communication in terms of moving all the alternative delivery channels, including mobile, ATM, Internet, and the like, and we are closely aligned with where they are going in that regard. I can't talk about the specifics of what BofA may or may not do, that is really inappropriate. But I don't really see that having a material impact in terms of our ability to service them as well as their movement to automation. I think it really enhances our position and credibility within their space. It may impact, as we have seen repeatedly on the security side of the business, but really for automation self-service, pretty confident in that move.

 

Kartik Mehta -- Northcoast Research

 

And Tom, just a little bit about the security business. Do you think -- is this is an issue where just for the next couple of years, the security business may reign tough because of what the banks are going through or do you think we are going through a period of change in that business, and a demand for security products, at least out of financial institutions has to be reset?

 

Tom Swidarski

 

Well, I think there's two aspects of that and we are focused specifically here on the U.S. relative to security and we talked specifically in terms of banking. You have got what I would call the physical security barrier types of products and then you have the electronic security. And it is really a tale of two cities in that the electronic security side and logical security side seems to have continued growth opportunities and a lot of activity there. The physical side, which is tied to a lot of the new construction advanced branch build, I think is going to be reset to a different level and we are looking at -- and we will talk a little bit more about that in the September analyst meeting, but we are looking at that business in terms of it being at a less level than it has been in the past -- we don't know exactly what that new norm is.

 

As I indicated in my comments, it is about -- branch construction is that about half of what it was over the last several years, and while it may bounce back a little bit, I don't see it going back to the previous levels, which means that we have to change our strategy relative to the physical side, in terms of having more to do with branch optimization kind of activities. And so we are hearing some strategies around that and we will be communicating I think a little more about that in our meeting in September with the analysts.

 

Kartik Mehta -- Northcoast Research

 

And then just a little bit on Europe, Tom. Would you strategy be to remain and focus on the countries where you are having success, or are you also thinking about maybe going to some of the other Western European countries, where you have not had a presence and maybe establish a bigger presence?

 

Tom Swidarski

 

Well, I think there are certain countries in Western Europe where we have a much stronger infrastructure and facility relationship. And a lot of the other countries, if you pick Spain for instance, we do have a presence there, we have a very specific niche that we are serving and while EMEA is the opportunity to move up the food chain, we also are very specific relative to the impact on pricing, and we don’t want to get ourselves in a position there in terms of chasing opportunities.

 

And so, we are very focused in that regard and want to be selective in the business that we do in areas that we think we need to have measured activity, and other areas where we think we have much greater competitive strength, we drive towards other differentiation in pricing in that regard is more in our favor. So I think, again, we are going to be very selective in what we do, use our competitive strengths in the countries that we have and make very specific plays or very educated plays in markets where we don’t have quite the same presence.

 

Kartik Mehta -- Northcoast Research

 

Thanks, Tom. I really appreciate that.

 

Tom Swidarski

 

Welcome.

 

Operator

 

And we will take our next question from Matt Summerville, KeyBanc.

 

Matt Summerville -- KeyBanc

 

Good morning. Couple of questions. Tom, can you talk a little bit more about the conversations you are having with small banks? It sounds perhaps a little more encouraging than discouraging at this point. And I guess you are talking about obviously a bit of a longer sales cycle with those customers, not a lot of pickup in activity in 2009. So are these conversations leading you to conclude that 2010 will be better in that cross-section of the market versus what you experienced in 2009, and are these small banks beginning to really think about widespread deposit automation deployment? I mean, one of the things that Kartik mentioned was that BofA article talking about branch closures. At the same time, another article was talking about the fact that half of BofA’s deposits are being done through intelligent deposit on the ATM, which I would think is the type of statistic that would very much support a turn in the small bank market.

 

Tom Swidarski

 

Yes, Matt, let me comment maybe on the deposit automation piece in small banks in general, and if I miss one of the other areas you wanted me to comment on, I will let you chime back in.

 

But in essence, we spent a lot of time discussing deposit automation to the major players and there is good reason for that. You know, BofA was really the U.S. market forward from a deposit automation standpoint. By the same token, we have I think approximately somewhere between 250 to 300, what I would call small bank customers, that have some form of deposit automation. And in many cases, maybe they have 10 branches and they are depositing it in two and they haven't rolled it out this year, but I think what we are seeing is, there is activity there, but no one has moved aggressively in 2009 on the deposit automation front on a wide-scale basis. But I certainly see the opportunity there to change certainly in 2010. Anything really we do this year in terms of taking orders or working with anyone, these are longer sales cycles and it takes a while for the operation to digest.

 

So really, you are almost talking about 2010 for all these conversations for the small and regional and the credit unions. But we are doing many demonstrations in that regard; we are having a lot of activity. I mentioned a renewed number of RFPs we are responding to, but again, because this sales cycle is long and many times, the deposit automation conversation with the small banks leads into the discussion of integrated services, because it is complex on the deposit automation front and certain pieces of the small bank may not be comfortable with. So it has led to a conversation on integrated services, which I think is healthy for us long-term, it is just it really does nothing for us in terms of 2009.

 

I think it positions us well in 2010, but certainly, we have to make sure that there is no further assessment from the FDIC or any other surprises that come out. So again, I would position ourselves as cautiously optimistic relative to the regional bank space for us. Certainly, activities are good, but as we tell our team, activities really don't mean anything until we get an order. So we are cautious in that regard.

 

Matt Summerville -- KeyBanc

 

Okay. And then, just in -- in the market itself, the small bank market, I will call it, in the US, how much would you estimate hardware sales will be down this year?

 

Tom Swidarski

 

Let me think about that for a minute. Are you talking about hardware sales just relative to self-service now?

 

Matt Summerville -- KeyBanc

 

Yes, just within the ATM business, the U.S., I will collect a small bank market.

 

Tom Swidarski

 

I would think it would be in the range of 30% to 35%.

 

Matt Summerville -- KeyBanc

 

Okay. Just -- you mentioned orders and I want to hit on that. In the press release, it was stated that ATM orders were down in the mid-20%, 25%, something like that. Obviously, that looks like a pretty big number. Last year, as I recollect, you had a couple of big bookings in Brazil that I think created a pretty tough comparison. Can you talk through how orders would have looked without -- if you remove the effect of that in the Americas and then overall for the company?

 

Tom Swidarski

 

Yes, and I think you hit on the critical issue here. Overall, as we communicated orders being down on a self-service standpoint, but again, if I kind of refresh everyone's memory, last year in the second quarter, we had two enormous orders from the Brazil market. I think it totaled somewhere in the neighborhood of 15,000 full functional ATMs. If you were to remove those, and do the year-over-year comparison, orders would be just about flat. So it would paint a very different picture relative to what occurred, given the unusual circumstance, from a self-service standpoint.

 

Matt Summerville -- KeyBanc

 

Within Asia-Pac, you obviously talked about being a little more front-end loaded this year. Will the orders that you have been receiving the last couple of quarters create a spike in Q3 like you had last year; and then how should we think about -- I mean, you are up against a plus 50 Asia-Pac comp in Q3. How -- your comments regarding the year being a little more front-end loaded, how does that play out?

 

Tom Swidarski

 

Yes. Again, as we look at the year, Asia-Pacific in particular, the part I mentioned was China, and China’s impact relative to the revenue side of the picture. Let me start there first and then --

 

The impact of revenue in China has a dramatic impact in terms of product margins compared to the other countries there in the region. So what we were communicating is much like last year, when we had a big second quarter as a result of the Beijing Olympics and people wanting to install and get the units up and running. The same phenomena occurred this year. So the second half of the year, we are going to have much weaker relative to the product implications as you start looking at the different countries and their impact, specifically in the third quarter.

 

So what happened was, in China, for us this year, a lot of the third quarter was pulled into the second, which had an impact on us in the second that we would have in the third and a lot of the order activity that we see happening in the Asia region, really has been a pickup in terms of India, Thailand, Indonesia, and some of the other areas that the profit margins are much lower. So while that is a positive story in terms of -- from an order standpoint, from a product margins standpoint, it has a different impact and obviously, the ability for us to turn that into service and services long term is really the key to success in those countries.

 

Matt Summerville -- KeyBanc

 

All right. And then just one final question. As we think about products and service margins in the back half versus where you were in the first half, all things considered including mix on the product side, would you anticipate any -- and obviously what you're doing from a cost standpoint, would you anticipate any sequential improvement; and then on the service side, I guess -- what does Diebold have to do to get another nice step function up like you have gotten to the 25.5%, and I just want to revisit the sustainability of that number.

 

Tom Swidarski

 

Okay. If you want, let me start on services, and then move to product. The high 10,000 foot level, from my vantage point right now looking at the third and fourth quarter, I would say product margins down, I would say service margins flat to slightly up, so some additional sequential improvement.

 

When you try and peel it back and get underneath there, from a service standpoint, we had a goal three-and-a-half years ago to get the 22%, 23% level and then we reset that to say we think 25% is achievable. And a lot of that has to do with the reduction efforts that we have through Smart Business 200 and productivity improvements that kind of come into line there as well as quality in the whole process relative to service and process improvement. So I am very confident in our ability to continue to marginally improve service as we go forward, from a gross margin standpoint.

 

And that the two big factors for us is really customer satisfaction, because if a customer is satisfied, then we have the ability to maintain pricing levels that make sense to them and if they are willing to justify; and then, customer satisfaction is really driven by the technical performance that we have been able to continually improve on the service side.

 

So I have seen continual improvement in terms of technical performance and I mentioned, picked it right the first time in response rates and a lot of the technical details that we measure and we find ourselves continuing to be able to improve those. Likewise, we are able to deflect manpower pretty effectively on the service side, which is an important factor in being able to maintain and continue to eek up on those service margins, and that is not just the U.S. story, that is really around the world that we are working through.

 

On the product side, I would say given the -- that is much more impacted by the country that you are doing business in and the size of the order. So again, as I mentioned, in the United States for instance, we are going to be doing or continue to see more activity in the large bank space and the small bank space and that mix certainly an impact on product margins. Likewise, as you look at Asia, when there is less China, not more China, then you have an impact relative to margin. So I see the pressure on the product margin side being greater in the third quarter and I see service margins being one that we can certainly maintain.

 

Matt Summerville -- KeyBanc

 

Thanks a lot, Tom.

 

Operator

 

And we will take our next question from Reik Read, Robert Baird & Company.

 

Reik Read -- Robert Baird & Company

 

Hi, good morning. Just going back to the U.S. market, with respect to the things that you have talked about, Tom, in terms of improving RFPs and some of the new equipment out there, it seems you are suggesting the 2010 market has a good opportunity, assuming that the capital budgets for 2009 really aren’t going to move, are you getting a sense that 2010 could be an improved year for those capital budgets at this point, and that is what is going to drive it?

 

Tom Swidarski

 

I guess, Reik, in this environment, it is really, really difficult to have visibility with the small banks, because there are so many and you have a number of conversations, but we have seen so many of the RFP activity, that is why I said there is a difference between activity and orders, and I haven't seen a change in terms of orders, so I would say, no, I don't have a real optimistic outlook at this point until I start seeing those activities turn into orders and that being a meaningful shift. So while there is more activity and while there is good conversation, the length of these conversations has seemed to draw on even further, and it doesn’t seem that the order pace really has picked up yet.

 

Reik Read -- Robert Baird & Company

 

I take it that the length of the conversations has more to do with the availability of funds than really testing or any infrastructure improvements that they would have to make otherwise.

 

Tom Swidarski

 

Yes, I would agree with that. I think that, again, as we view the deposit automation conversation, it is a significant investment for them and it is a change of their operation if they want to do it right. So it is something that they pause and usually go to a higher level within most of the small banks and decisions are made at the executive level. As you get to that decision, then it becomes -- integrated services, even a better way to approach this and allow us to take over the operation, including deposit automation, which again, these conversations takes some while, but again, as I would point out, the cautiously optimistic is that the activity is taking place, whereas I would say in the first quarter, people didn't even want you to show up and have the conversations. We are now having those, which is an encouraging sign. But again, until we start seeing orders in the order book picking up to the levels that year-over-year comparisons make sense, I would say our outlook for 2010 still is not optimistic with the regional banks right now.

 

Reik Read -- Robert Baird & Company

 

Okay. And then going back to Asia. I mean, it seems like you guys are with some frequency having orders pulled forward and I guess the question is, is that maybe just part of the normal progress of things, is it there really is no normal seasonality over there, because the penetration rates are so low that you are regularly going to have this level of upside?

 

Tom Swidarski

 

Well, Reik, we have a lot of those conversations ourselves as we look at our internal forecast. And yes, I think that because of them being a lot of developing markets and the activity pace has certainly picked up the last several years for us in that market, we are trying to reach them with the new norm. I think the good news for us is, we are very heavily involved in a lot of these activities and seem to be positioned well across the entire regions from the order and the delivery standpoint. So that is a positive. What the new norm is, we are going to be figuring out here as we kind of march to the end of the year and once we have a better handle on it, we will be able to communicate a little more crisply, but right now, the good news is it has provided -- continued to provide upside for us.

 

Reik Read -- Robert Baird & Company

 

Okay. And then just -- on the European front, with the production weakness, are there any things that you guys can do in the near term to either adjust costs downward from other regions drive revenue through there is or is it, you are just kind of stuck with it, you are up to improve?

 

Tom Swidarski

 

Well, I think one of the challenges we have in the regions like Russia and Eastern Europe; we still rely on distributors in many of those regions. So unlike our own organization, where you could flex, take costs out on the service or whatever side, we don’t really have costs that is easily able to flex in that regard. And particularly Europe is the region where we have the most distributors.

 

The second is, we are certainly attempting to flex the Budapest facility in terms of manufacturing, but the volumes are so far off year over year that that really has not -- we cannot flex enough, we will put it that way. And those volumes are down. We would certainly expect that we would get back to a more normal situation relative to Hungary and we are certainly looking at our global footprint in terms of what makes sense from a manufacturing standpoint and we will be talking and discussing that a little bit more with you when we are with you in September down in the Lexington facility.

 

Reik Read -- Robert Baird & Company

 

Okay, great. Thank you, Tom.

 

Operator

 

And our next question comes from Gil Luria at Wedbush.

 

Gil Luria -- Wedbush

 

Yes, thank you, good morning. We have had a couple of contradictory commentaries from your two big competitors about the global pricing environment. So I wanted to get a sense for how you perceive it. Is there a significant acceleration of year-over-year declines on a global basis, or is more a matter of having specific contracts and specific regions being a little lower than usual?

 

Tom Swidarski

 

Yes. Gil, if you can, I would break those into two pieces. So, because we talked a lot about service, and I want to separate service from product. So what I would say from a service standpoint -- from a service pricing standpoint, I feel that that is very stable. And again, I think in our case, because of our performance, we have been able to maintain those levels, and in some cases, be able to pass along a very slight increase, which is getting more and more difficult in this environment.

 

And if I look on the pricing side of product, I would say that what I see there is -- it is fairly normal in terms of (inaudible), but the countries where you have the biggest pricing pressure, well, no surprise India is one of the most competitive pricing environments for product and that just kind of I think forces business. There have been some selective deals, large play deals, in regions where pricing gets too aggressive and that we have walked away from, but I would say overall, and if I pull those out, I would say the pricing is at regular historic levels, and I haven't seen any major deterioration or any price acceleration, and when they get to that point, as I said, we have been fortunate enough to pull ourselves out in those cases.

 

But again, it is almost the big volume or the big opportunities are the ones where you would see some pricing pressure and I think that is really to be expected. So I would say overall, my answer is -- it is the same answer I gave maybe the last several quarters that I feel pricing is relatively stable. There is always a lot of challenges out there, and on the product side, certainly much more pressure on product than service, I think that is more reflective of our performance.

 

Gil Luria -- Wedbush

 

Got it. Now (inaudible) and J.P. Morgan have made some comments recently about extending the deposit automation rollout to Wachovia and Washington Mutual. Could this also translate to some activity in terms of branch refurbishment that will help stabilize the security business?

 

Tom Swidarski

 

Yes, I think in Chase’s case, they have obviously made their acquisitions for Washington Mutual, and we are heavily engaged on the security side with them in terms of renovations for those facilities. So it will have a positive impact for us relative to -- on the security side of the business, and certainly, I am sure there's going to be other acquisitions and other activities that happens kind of across the board and I think the good news from our perspective is, we have the infrastructure really across the United States. We have deposit automation in every one of the 50 states. So we have got service technicians and infrastructure in the states. We can draw on expertise and experience that we have in states that have had like major rollouts and utilize those and move folks around. We have got installation and planning coordinators and project management expertise that we can deploy.

 

So I feel good about our capability, and it is not just at the big bank level as that moves, and maybe with more pressure to win a couple of big banks are moving to deposit automation in an area or a smaller town that someone has to react in from a competitor standpoint. We have got capability of technicians of being able to install and get those up and running, so I think that will bode well for us, once the small banks start moving forward. So I think the acquisitions right now will have a positive impact relative to the security side of the business in the latter part of the year and I am hoping deposit automation starts to have an impact for the regional banks sometime in 2010 and beyond, but again, we have yet to see that happen.

 

Gil Luria -- Wedbush

 

And then, you mentioned that you are evaluating your manufacturing and you have already consolidated a few plans, NCR just retreated from their move to outsourcing. So that means that that option may not be as attractive as it seemed in the past. What more can you do, where can you take that forward, is there big changes that you can make or is it a lot more of the efficiency measures that you have been taking?

 

Tom Swidarski

 

Yes, I think it is a continuation of what we have been doing in efficiency measures and as we now have the three major distribution centers in the United States and they are working with the plant here in the US, the plant from overseas, I think there is still work we are doing relative to adjust those process improvement leads, as well as making sure we have got the sourcing tied closely to those facilities. So I wouldn't say there is probably any dramatic step we can take, but again, I think it is continuous improvement that we are looking for and driving to that yields sustainable results.

 

Gil Luria -- Wedbush

 

Great, thank you.

 

Operator

 

And we will take our next question from Zahid Siddique, Gabelli & Company.

 

Zahid Siddique -- Gabelli & Company

 

Hi, good morning. Couple of questions, Tom. First, what is your estimate for CapEx for the year?

 

Tom Swidarski

 

Let me have Leslie answer that.

 

Zahid Siddique -- Gabelli & Company

 

Sure.

 

Leslie Pierce

 

CapEx, I would expect in like the $50 million range.

 

Zahid Siddique -- Gabelli & Company

 

So I guess it is about the same as what I believe you had said before.

 

Also now, I was wondering if you could comment a little bit more on the FDIC insurance costs. I think you said it was five basis points. Just what impact do you think you may have from that?

 

Tom Swidarski

 

Well, what I was indicating is the five basis points I think is based upon June 30 balance sheet that the FDIC looks at. And then, the banks will be paying that by September 30. The issue that I see there, and again, there is a lot of different viewpoints you get, is the number of bank failures had been earlier talked about in the range of 100, and now, with our latest conversations with folks close to the situation, some folks are telling us it could be in the 200, 300, 400, 500 range, which would mean that again, it would put pressure on the FDIC and as such, the concern is whether there would be some additional special assessment like that, which obviously dampens people's ability to move quickly, and especially in the small midsized banks.

 

Now, none of that has been decided, none of that is firm, we don't know how many banks in fact are going to fail, but again, because there is still some of these clouds that remain over there or are outstanding, I was hoping that this assessment would happen, people could get on with lives and know how to plan, but now they go into next year with a little bit of this uncertainty. So again, it is just another issue that has created a little bit of a dampening effect from my perspective in terms of more impact on the smaller banks ability to move forward with deposit automation integrated services. So that is just another headwind.

 

Zahid Siddique -- Gabelli & Company

 

Sure. And just so I could quantify the number, for an average small bank, what would you think this number is? Let us maybe think in the terms of the total cost in dollars. Let us say the total cost is $100. What would this 5 basis point impact be? Is there a way to quantify it?

 

Tom Swidarski

 

You can quantify it exactly. It is five basis points of their asset base. So you just multiply it out and each bank is then impacted. So they know the amount, they have taken it, whether some may have deferred capital investments to use it, I mean again, this all occurred this year, so it has impacted their budget, but each of them has the exact number in their hand and is hammering it accordingly. My only comment there was in terms of 2010, because there is not 100% certainty whether there is a potential of something else happening if more banks fail, then that creates a little bit of uncertainty there for what budgeting looks like and that obviously has an impact on us and all the other technology providers.

 

Zahid Siddique -- Gabelli & Company

 

Okay, just one last question. Any review or revisit to the share buyback program?

 

Tom Swidarski

 

No, not right now, Zahid. I think, especially in this environment, we are -- we certainly want to make sure we are fortified; we have got ourselves oriented toward making sure that we bolster the balance sheet, the credit facility that we are working our way through, so I think that is really the focus right now.

 

Zahid Siddique -- Gabelli & Company

 

Thank you.

 

John Kristoff

 

Bill, I think we have time for one last question.

 

Operator

 

Very good. And that last question comes from Edward Wheeler, Buckingham Research.

 

Edward Wheeler -- Buckingham Research

 

Hey, good morning, Tom and everyone. Two questions, quickly. What would be the percentage of your shipments in the financial self-services product area? What would be the mix of those that reflect deposit enhanced deposit technologies?

 

Tom Swidarski

 

It varies by quarter, but if you hang on one second, I think I might have a sheet here. I think this past quarter, it was in the neighborhood of 40% that were deposit enhanced -- I mean, had some function of deposit automation capability. Obviously, that has an impact on where the orders are coming from and that, but I think about 40%.

 

Edward Wheeler -- Buckingham Research

 

I can't recollect my notes, but I think it probably was under 20% last year, wasn't it, or is it -- if you went back in the first half of last year?

 

Tom Swidarski

 

It has continued to grow over time. So that when people are ordering full function units now, generally speaking, they have some type of deposit automation, whether it be a cash module, whether it be a check module, or whether it be -- from the Asian markets recycling. So, it would be a combination of those three.

 

Edward Wheeler -- Buckingham Research

 

Okay. And the other question I kind of wanted to review would be the pipeline of security projects I think you described as being strengthening and building up. And is that across all verticals, or is there any particular work you would highlight as to where the bidding activity is improved?

 

Tom Swidarski

 

Yes, I think the way I would view that is if we look at each of the verticals, commercial and government for us clearly are the strongest in that regard. So those are still small pieces of our business, but maybe 20%, 30% kind of improvements there, but you have financial piece of security down so significantly, it kind of overrides them.

 

Edward Wheeler -- Buckingham Research

 

And that includes the bidding pipeline?

 

Tom Swidarski

 

Yes, that is correct. And retail is basically flat. Again, retail, commercial, and government are relatively small when you look at the total $800 million in revenue we do in security.

 

Edward Wheeler -- Buckingham Research

 

Great, thank you.

 

Tom Swidarski

 

You are welcome.

 

Operator

 

And, Mr. Kristoff, I would like to turn the conference back over to you for any additional or closing remarks.

 

John Kristoff

 

Thanks, Bill. Before wrapping up today, I would like to mention two upcoming events.

 

On September 2, in celebration of our 150 Anniversary, Diebold will be ringing the opening bell at the New York Stock Exchange. And on September 16, we will hold our Investment Community Conference at our manufacturing facility in Lexington, North Carolina.

 

Thank you for joining us this morning and as always, if you have any follow-up questions, please feel free to reach us or me directly. Thank you again, Bill.

 

Operator

 

And again, that does conclude today's conference call. Thank you for your participation.

 

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