Diebold Nixdorf, Incorporated
Q1 2015 Earnings Call Transcript

Published: 30 Apr 2015

[Operator:]

Good day, everyone and welcome to Diebold, Incorporated's First Quarter 2015 Financial Results Conference Call. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Vice President and Chief Communications Officer, Mr. John Kristoff. Please go ahead, sir.

[John D. Kristoff:]

Thank you, Kyle. Good morning and thank you for joining us today for Diebold's first 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've provided a supplementary presentation on the Investor page of our website. Andy and Chris will reference this presentation as part of their comments today and we encourage you to follow along. Also I'm pleased to report that Steve Virostek has joined my team as Vice President Investor Relations. We brought Steve onboard to continue our efforts to improve disclosure, expand coverage, and grow and diversify our shareholder base. Steve has more than 15 years of IR experience in the IT services and technology space, most recently with Computer Sciences Corporation and prior to that with Sprint Nextel. I will continue to oversee IR in addition to Communications and Marketing, but Steve will be taking on many of the day-to-day IR activities in the coming months. Steve?

[Stephen A. Virostek:]

Thanks John. I'm really excited to be part of the Diebold team here and be part of this dynamic industry. I look forward to interacting with all of you on the phone, our analysts and our shareholders. Before Andy and Chris discuss the Q1 results, I'd like to remind our listeners that as with previous calls, we are excluding certain restructuring charges and non-routine expenses from our non-GAAP financials. We believe that excluding these items provides a good indication of the company's baseline operational performance, and as a result many of our remarks will focus on non-GAAP financial information. For a reconciliation of GAAP to non-GAAP financials, please refer to the supplemental materials at the end of the presentation. Moving to the next slide number three, I'd like to remind our listeners that some of our comments may be considered forward-looking statements and our performance may deviate from these statements. They are subject to risks and uncertainties. Please refer to our detailed discussion of risk factors on file with the Securities and Exchange Commission. A replay of this webcast will be available later today. Please keep in mind that the information discussed is only current as of today and subsequent events may render the information in the webcast out of date. And now with the opening remarks, let me turn the call over to Andy.

[Andreas Walter Mattes:]

Thanks Steve. Good morning and welcome to all participants. Thank you for joining our earnings call today. We are off to a good start in 2015 with a solid top-line growth in our core business, gross margin expansion and non-GAAP earnings growth. We also delivered broad based growth in orders which include a number of new logos and innovative wins with marquee customers. And we are making tangible progress in our transformation to a more services led software enabled company. We are transforming our software portfolio with the acquisition of Phoenix Interactive Design, a highly regarded provider of brand automation software. Phoenix will become the foundation of our software business as these solutions deliver the omni-channel experience across all manufacturers' hardware. Adding this IP as well as a highly talented workforce enabled us to pursue a greater share of the total addressable market or TAM. This strategic addition to our company has been very well received by customers and employees alike. Turning to financial results on slide 6, the financial self-service business was particularly strong in the quarter with 6% revenue growth or 12% in constant currency. We've reported growth in every region of the world. We are growing faster than the market by collaborating with customers to deliver a broader solution set. In the security business revenue increased by 5% during the first quarter led by electronic security growth of 9% and aided by the fact that physical security was relatively flat year-over-year. Our electronic security business continues on its positive trajectory as the increased sales coverage begins to show early results. We improved total company gross margin by 270 basis point year-over-year to 26.7% with strong gains from both product and services. This improved profitability confirms that our investment in global systems and processes are yielding tangible results. Operating margin expanded by 40 basis points year-over-year on a non-GAAP basis. This includes our reinvestment in upgrading back office systems and enterprise IT. We will continue to make these investments, however, the absolute spend will begin to gradually decrease towards the end of the year. From an earnings perspective, non-GAAP EPS was $0.29, a 21% increase compared with the prior year. While we're off to a solid start in 2015, currency headwinds strengthened during the quarter and the political environment in Brazil has become more volatile in the wake of recent events. Therefore we feel it is prudent to take a more conservative view on our non-GAAP EPS outlook for the year. Now, let me speak to our positive order entry performance in the first quarter on slide seven. We are very encouraged by the 4% growth in total assets as orders, or 10% growth in constant currency. In North America total orders grew 4%. During the quarter we won a number of marquee deals including an agreement with Walmart to outfit its stores in North America with the latest financial self-service technology. The agreement includes information security solutions, software, managed services and more than 2,000 of our recently launched new family of ATMs. We began deploying the first ATMs and related services for Walmart in the first quarter of 2015 and expect the majority of the deployments to take place in 2016. This is Diebold's largest retail market win in the company's history. We also won a multiyear services deal with BBVA Compass to maintain their multi-vendor ATM fleet in the United States. BBVA Compass represents a new logo for us as the bank currently has no Diebold's hardware in its ATM fleet. This is an important deal for the company as it demonstrates our ability to win new customers by leading with our services capabilities. Our first quarter accomplishment demonstrates that Diebold is winning on two fronts, world class services and collaborative innovation. It is too early to declare victory but we are very encouraged by our progress in the quarter. Moving on to the security business, orders in North America grew 5.5% with continued strength in electronics security up high single-digits. We attracted 11 new logos to our ES business and continued to grow recurring monthly revenue as a percentage of total orders. In EMEA we generated reasonable FSS orders given a very difficult comparison versus one year ago as well as coming off a fourth quarter of strong order growth. As we are taking a targeted account approach to sales in this region and working from a relatively small base, year-over-year comparison can vary greatly from quarter to quarter. We have a very strong order pipeline and remain optimistic about our growth opportunities in this region. In Asia Pacific, orders increased by 8% year-on-year. In China, we grew orders 3%. However, we are continuing to see a tendency in China where the government is encouraging banks to increase their use of domestic technology providers. Outside of China we saw substantial growth in other areas such as Southeast Asia. In addition, we've had some success in Australia where we recently announced an expanded software and services contract with Suncorp. Diebold is assisting the company with the next phase of its multi channel strategy. Our market position in Australia has been further augmented by our recent acquisition of Phoenix as we now have a number of key software accounts in the geography. In Latin America, total FSS orders increased nearly 50% representing record order growth for the region. This increase was led by strength in Mexico, a market where we are regaining share. Our success in Latin America demonstrates what is possible when new leaders, new spirit, and new solutions meet with exciting market opportunities. Moving on to slide number 8, I'd like to spend a few minutes on the dynamics within the financial self-service industry as our customers are evolving their retail delivery model and how our own transformation helps strengthen our position as a strategic partner. Our clients are facing increased consumer demand across multiple channels, at the traditional branch, in retail locations, online and mobile. While financial institutions agree that they must bring together the best elements of the customer experience across each channel, there is no one-size-fits-all approach and how to build and deliver that omni-channel experience, which is why a strategic partner is needed to address the complete value chain, consult, design, build and operate. Diebold is embracing these dynamic trends together with our customers through collaborative innovation. For example, with help from our Innovation Center in Brussels, we designed, built and deployed 400 self-service kiosks for UBS. This custom omni-channel solution for the European market was delivered in about six months, which demonstrates our increased flexibility and agility as a company. In the security business we accelerated our time to market for streaming cloud based video services by partnering with Eagle Eye Networks. These new solutions will stream and store video, provide flexible cloud storage and generate notification and real-time analytics that are managed through our SecureStat platform. As you can see, continued investment in software and services enables the company to move up the value chain and expand our share in the evolving industries we serve. Now looking at the cost structure of the business, as we communicated, the benefits are starting to show up in the gross margin, yet we're still in the midst of our foundational work to becoming a better company on the many fronts we've previously outlined. This work is evident in our increased OpEx spend. Chris will provide more color on the magnitude and timing of our reinvestments in his commentary. We're also making progress towards instilling a winning culture at Diebold. In previous calls, we have discussed the influx of new talent at the leadership level within Diebold. As the turnaround gains momentum, we're becoming a destination for talent. In fact, the number of unsolicited CVs we are receiving today is more than double the number that we received a year ago. We've done a lot of work at the top of the company. With the senior leadership team now in place, we continue to strengthen our broader leadership bench. For example, we're in the final stages of hiring new leaders for Brazil and India and we're starting to see results from the new leaders we brought into the company. When I think about what we've been able to accomplish recently in Latin America, Asia Pacific and EMEA, it is clear that our new leadership team is driving positive change. The team is starting to come together with a unified focus on innovation, collaborating with customers, broadening our solution set and winning in the marketplace. We recently brought together about 100 top leaders to discuss our plans to transition to the walk phase of the turnaround in 2015. It was exciting to see the level of energy developing among the broader leadership team. To summarize, the company had a good quarter on many fronts, financially, operationally and strategically. We said at the beginning of our transformation that most of our success was based on a large dose of self-help. We are delivering on all four tenets of our Diebold 2.0 turnaround program

[Christopher A. Chapman:]

Thanks, Andy, and good morning, everyone. I will start off by walking through our first quarter financial performance and then provide an update on our 2015 outlook. As you have probably already seen in our materials, we made a small change in our external reporting segments to reflect how we manage the business internally. Our Brazil and Latin America regions have been consolidated into one region, which we will refer to as Latin America. The historical results of the two individual regions can be consolidated to provide comparisons to the new segment structure. Now turning to revenue, starting on slide 12, total revenue decreased 4.8% as reported but increased approximately 1% in constant currency. As we have previously communicated, the Brazil Other business had significant activity throughout 2014 which will not be repeated at the same levels in 2015. Focusing on our core business, FSS and security grew 6% as reported or approximately 11% in constant currency. Latin America excluding Brazil Other had solid growth of 17.5% in constant currency. As we noted in the fourth quarter, there is strong order activity and momentum in this region and it has materialized in the solid performance in the quarter. EMEA and Asia Pacific showed growth over the prior year, both up 3% on an as reported basis. Adjusting for currency, growth for the quarter was 24% in EMEA and 5% in Asia Pacific. Finally, North America grew 7% including a slight impact from currency. As you can see, currency had a significant impact on our first quarter results. Currency headwinds are expected to continue as we move forward in the year and I will provide more detail on this shortly. As we move to slide 13, financial self-service revenue was up approximately 6% as reported with increases in all regions, led by North America, EMEA and Latin America. On a constant currency basis, FSS revenue was up 12% with all regions reporting growth in the quarter versus the prior year period. North America grew high single digits, primarily due to a large deposit automation project and increased volume in our regional account business. On a constant currency basis, EMEA increased 24% as we continue to execute our account-focused strategy in the region. In Latin America, we had approximately 19% growth adjusting for currency driven by the strong activity previously highlighted. Total security revenue on slide 14 increased approximately 5%. Electronic security revenue increased approximately 9% or 11% in constant currency with a 1% decline in our physical security business. The electronic security business represented approximately two-thirds of our total security revenue. Looking at slide 15, Brazil Other was down $69 million in the quarter due to the delivery of a large IT technology project in the first quarter of 2014. On slide 16, total gross margin improved 270 basis points to 26.7%. A major contributor to this improvement was service gross margin increasing 230 basis points to 30.7%. We are pleased with the continued service gross margin improvement over the past several quarters as a result of our global service transformation efforts. Product gross margin increased 230 basis points to 20.7%. The increase was primarily the result of favorable solution mix and higher volume in North America. Moving on to slide 17, total operating expense was 22.1% of revenue compared with 19.7% in the prior year period. We continue to make foundational investments in IT, back office, and R&D, as well as strengthening our business processes and controls. Year-over-year operating expense comps will remain difficult in the second quarter of 2015 as we started to ramp up our reinvestment activity in the third quarter of last year. Turning to slide 18, as we previously communicated we have realized $55 million in net cost savings program to-date through year end 2014. As I just highlighted, our 2015 reinvestments will be weighted heavier towards the first half of the year representing approximately two-thirds of our expected $20 million reinvestment. We are on track to realize $40 million in gross savings which after investments will result in an additional $20 million in net program savings by the end of the year. Turning to slide 19, non-GAAP operating profit increased 4% or 16% on a constant currency basis. Our operating margin increased 40 basis points to 4.7% as we have improved our underlying operational performance while funding our reinvestments. The company is maintaining a strong focus on improving this cost structure such as the recent Latin America consolidation especially given the continued pressure from currency. Looking at operating profit by segment on slide 20, North America improved $8.3 million or approximately 14% versus the prior year. This increase was driven by higher volume in our regional business combined with benefits from our service transformation efforts and cost reduction actions. EMEA and Asia Pacific improved approximately 10% and 8% respectively. In Latin America operating profit decreased $8.4 million due to our cyclical Brazil Other business. The change in the global and corporate line reflects the business reinvestments that we have been highlighting. In summary when excluding the impact of Brazil Other, there was broad based improvement in all regions compared with the prior year. EPS on a non-GAAP basis was $0.29 for the quarter. This excludes restructuring charges of $0.05; legal, indemnification and professional fees of $0.04 and the impairment of legacy Diebold software following the acquisition of Phoenix of $0.09. In addition, we realized an $0.08 impairment related to the decision to exit the company's Venezuela joint venture and $0.07 tied to the impact of the bolivar devaluation. Due to our inability to exchange the Venezuela operations bolivar cash balances, because of restrictive currency controls and corresponding impact on our ability to effectively run the business, we decided to exit our direct presence in Venezuela and move to an indirect sales model. Therefore we are excluding the Venezuela impairment and currency devaluation impact from our non-GAAP results in 2015. The non-GAAP effective tax rate came in at 26.5% compared with 33% in the prior year. Moving on to free cash flow on slide 22. Our free cash flow results reflect a $73 million free cash use which increased approximately $34 million from the same period last year. This is primarily due to working capital expansion tied to our first half business activity, a voluntary pension contribution of $10 million and slightly elevated capital expenditures. Turning to slide 23, DSO reflected an increase of 7 days to 61 days in the quarter versus the same period last year, primarily due to geographic mix and timing of revenue within the quarter. Inventory turns reflected a small decrease of 5.3 turns compared to the first quarter 2014 of 5.4 turns. Net debt on slide 24 for the period was $238 million, an increase of $191 million from year end 2014. The increase in net debt is largely attributable to the acquisition of Phoenix. In addition, net debt was also impacted by an adverse exchange rate on cash balances as well as seasonal working capital expansion. The company's net debt-to-capital ratio was 23% at the end of the current quarter and 4.5% at the end of 2014. Looking at our outlook on slide 25, we are adjusting our full year 2015 assumptions to reflect greater currency movements than previously outlined. In February, we projected an approximate 5% currency impact primarily attributable to the real and euro. Based on recent rate movements we now expect an approximate 6% currency headwind for 2015. As a general rule of thumb, based on our current geographic mix of business, a 1% currency impact on top line falls out at approximately 15% on the bottom line. We are maintaining our projections for total revenue to be down approximately 5% to 6% for the year as the currency headwind is partially offset by revenue from the recent acquisition of Phoenix. However, we expect earnings impact in Phoenix to be neutral in the year, inclusive of integration costs and the impact of purchase accounting on the top line. Looking at revenue on a constant currency basis, we are maintaining our guidance for our core business with 4% to 6% growth in FSS and relatively flat revenue for security. On an as reported basis, FSS revenue will be flat to up 2%. In addition to the impact of currency, we have also adjusted our outlook to reflect reduced expectations in our Brazil business. We are seeing a delay in purchase decisions among the government banks, due to the current political situation, which we expect to impact the near term purchase activity. As a result, we are adjusting our non-GAAP EPS to be in the range of $1.70 to a $1.90. In terms of earnings expectations on a seasonal basis, the year will follow our normal seasonality and be weighted more heavily towards the second half. We are maintaining our free cash flow outlook for the year of approximately $120 million, which includes an approximate $5 million increase in capital expenditures and a $10 million to $15 million voluntary contribution to our North America pension plans. We also continue to expect the full year non-GAAP tax rate of approximately 30%. Overall we are focused on consistently executing our Diebold 2.0 turnaround strategy and we remain steadfast in our focus on long-term improvements while laying the foundation for future growth. With that, I'll open up the call for questions.

[Operator:]

Thank you. And we'll take our first question from Gil Luria with Wedbush Securities.

[Gil B. Luria:]

Yeah, thanks for taking my question. Good morning. In recent memory, I don't remember, such a divergence in performance in the ATM business between the three different companies. It seems like that means the market's doing well, but it also means you're taking share since you had the strongest performance of the three companies. And particularly you called out Walmart in the U.S., and if my memory isn't mistaken, they recently deployed, relatively recently within the last two years or three years a competitor's solution. So what is it that's helping you gain share right now? And does the Phoenix acquisition play into that in terms of strengthening your software capabilities?

[Andreas Walter Mattes:]

Well, Gil the biggest thing that differentiate Diebold is our ability to provide a total package consult, design, build, and operate. If you take a look at the Walmart deal, it's truly a managed services deal over many years. And you're correct, we are replacing a competitive installation there with very innovative solutions as Walmart is going into the financial services space and we're offering functionality like bill pay or money transfer on our machines, which brings us to the second thing which is collaborative innovation because they approached us and said, "Listen, we're trying to do this. We're trying to get our arms around the space," and we were able to satisfy their requirements in a very short period of time. So those two are the main differentiators in the market. If you were to add up all the wins we had in Q1, because as a matter of fact also a lot of the Latin America wins were services led deals, we contracted north of a $100 million in total contract value, which is going to monetize over the next four years to five years. With regard to Phoenix, Phoenix is yet going to one-up our position in the market as it will give us a really broad software offering. It gives us the opportunity to provide thin client server architecture and do that and that's the important thing across all vendors hardware alike, because customers don't want to be pinned in to just one competitor's ear. They want to have the flexibility, yet have one common user interface. So we're super excited we're opportunity rich, and we got a lot of work ahead of us.

[Gil B. Luria:]

Got it. And then in terms of Brazil, a very well publicized issue there, having their internally the President there. What's the mechanism? What's the connection between – what, the big political issues having there and your new outlook about the Brazilian ATM market?

[Andreas Walter Mattes:]

Look, it's actually very, very simple Gil. Given all the political noise that is in the system and given the fact that there is a new government in place in Brazil since late fall last year, some of the key jobs in the government banks have not been filled. So one of our top customers is looking at issuing a big RFP, but there is no executive at the bank who can actually authorize the issuance. So it's just the normal thing until you get more clarity, people know who's on first and who's is going to take responsibility for what and that will impact decision-making patterns and buying patterns not from whom they like, but from when they are ready to make a decision. And we thought it was prudent to foreshadow that.

[Gil B. Luria:]

Got it. Thank you very much.

[Operator:]

We'll take our next question from Paul Coster with JPMorgan.

[Paul Coster:]

Thanks. First question, how much revenue can we associate with the Phoenix acquisition maybe on the run rate basis?

[Christopher A. Chapman:]

I'm not going to give the forward looking from a run rate standpoint. I would say in 2015 it will be shy of 1% and again we're losing some of the top line impact this year just due to the rules around purchase accounting and we'll continue to give more clarity on that software as we move forward.

[Paul Coster:]

So I think I heard you say it's about 1% of growth. Is that correct for the company?

[Christopher A. Chapman:]

It will be a little bit south of 1% in 2015.

[Paul Coster:]

Okay, got it. The free cash flow was a little bit weak at the beginning of this year and it looks like the accounts receivables and so on were up. How is this year different from prior year? And last year I think the second quarter was the worst quarter from a cash flow perspective. Is it going to be a slightly different shape this year?

[Christopher A. Chapman:]

To get the first part of the question there, first quarter what was different, again, we had the $10 million voluntary contribution to our pension. So again that was an addition from where we were at prior year and what you just highlighted there on the receivables. Again, just the timing of our revenue and how that worked out from a collection standpoint had our DSOs a little bit higher. So we see the working capital expand a little bit more in first quarter from where we were at in prior year. I expect that to, we'll say, move back to prior levels from a DSO standpoint here in the second quarter and as we move forward. And then expect the full year total cash flow to follow a fairly similar path that we've seen in the past with our fourth quarter being the strongest cash generation quarter of the year.

[Paul Coster:]

Okay. Fun question for Andy. I mean, it looks to me like you're already walking or running or something. How are things going to be different as we go from crawl to walk? It feels like things are already a little bit different.

[Andreas Walter Mattes:]

Look, I think we've used the term that we're eyeing walk in previous conversations, Paul. We are right at the cusp of it. We got to get the foundational projects behind us. Right now we're in transition idiosyncrasies, get that out of the system to make sure we can focus the complete energy on the company, on the fourth pillar of our turnaround strategy, which is growth. The encouraging news is that we see our order pipeline increasing. We see that across all geographies. And the fact that services led asks are coming in by themselves is something that makes us feel very optimistic about the future. And then you just mentioned Phoenix. That's yet another integration we got to get done. Phoenix is going to be the core of our software platform. We need to make sure we're going to train everybody around the globe and then we'll take the software asset and give it a much broader footprint than it ever had in the past.

[Paul Coster:]

Okay, thank you.

[Operator:]

We'll take our next question from Joe Radigan with KeyBanc.

[Joe K. Radigan:]

Thanks. Good morning, guys. First, a couple of questions on the guidance. Andy, typically you have line of sight to two-thirds of your revenue heading into the year. You had a very strong orders quarter in Q1. Where could there be upside or downside versus kind of your guidance expectations, aside from FX, which obviously you can't predict that, but how confident are you in this range and where could there be potential upside?

[Andreas Walter Mattes:]

The biggest volatility we have in our forecasting models is Brazil. And given the fact that Brazil is roughly 12% of our overall revenue, it's a meaningful number and these decision cycles, these projects can swing. And if you then take into consideration that the real moved, I think it moved in a band of plus/minus 10%, 12% over the last six weeks to eight weeks, and you then take into consideration that some of the revenue outlook is more heavily weighted to the end of the year, that's where you got the variability in the model. On the other side, the more deals we win the higher our upside.

[Joe K. Radigan:]

In terms of the seasonality of earnings, I mean, Chris, you mentioned that it was going to be back half weighted again. Compared to last year where it was about a 40-60 split, I mean do you expect a similar cadence this year or is it going to be more back half weighed just given the first half reinvestments and how the backlog is going to flow through the year?

[Christopher A. Chapman:]

No. I think it's going to be a very similar pattern that you saw last year, could be a little bit more activity towards the back half, again depending on how some of the large deals happen to move. But I think you're thinking of it right from a timing standpoint.

[Joe K. Radigan:]

Okay. And then lastly on that Walmart order. Is there potential for a follow-on order and does that include a service contract as well, I think I heard you mention?

[Andreas Walter Mattes:]

Let me start with the second part of your question. It is actually a multiyear managed service contract.

[Joe K. Radigan:]

Okay.

[Andreas Walter Mattes:]

So it clearly falls into the category of services led. By the way, it's also an interesting situation, because we always get asked how big is branch automation and now you get into the head scratcher is Walmart as they're entering into the financial services space. Is that a branch in the making or is that – how would you classify that? So we see a lot of opportunities there with Walmart. We see a lot of opportunities with other retailers. We see opportunities with banks moving into the retail space, because what people are trying to do is offering financial services to a broad population at a very convenient place and everybody's got to buy groceries and household staples. So it's a very interesting market. And if you add another fact to it, our Phoenix friends already are the providers of the software layer for Publix. So we now have within one quarter two legs to stand on in the emerging financial support industry in the North American retailers. So we're super excited about it.

[Joe K. Radigan:]

Great. Thanks, Andy. Thanks, Chris.

[Operator:]

We'll take our next question from Matt Lipton from Autonomous.

[Matt Lipton:]

Thanks, guys. Good morning. Andy, as you think about integrating Phoenix into your business, I saw the small impairment charge. So when you think about your branch transformation products, your video teller ATM product, are you going to be backdating or adding Phoenix software to those products and replacing the old Diebold software? And then how long does that process take?

[Andreas Walter Mattes:]

Well, look, the devil on these things is always in the detail, but let me start for instance to give you an example. The largest deployment of our video teller that's out there in the market is actually already today a combination of Diebold's IP and Phoenix IP. So that's already integrated at our largest account. Going forward we're going to make Phoenix the core, the kernel of our software platform, because it's multivendor, it's across all hardware environment and it's absolutely omni-channel in its setup. Having said all of that we will continue to support our Agilis customers. As a matter of fact we are currently working on a thin layer of Phoenix omni-channel capability that we can upgrade our Agilis customers to, so that in the very near future if you're an existing Diebold customer, you can keep what you have, but you get all the advantage and the access to the new technology that we just acquired.

[Matt Lipton:]

Got it. And then, I mean more broadly on this concept of multivendor software, it's something we've spoken a lot about, but how important is this as a software piece to being able to cross sell, or sell some more product to customers that might be using the current Phoenix software package?

[Andreas Walter Mattes:]

Look it's super important. And the reason behind that is very simple. There is a consultation in the financial services market going on. And if one bank acquires the other chances are their infrastructure is slightly different. So if you're the Head of Retail, all of a sudden you end up with a mixed media environment, but you want to have one face to the customer, one consumer approach. You want to be able to serve all constituencies of your old and your new acquisition target. So you need one layer across all of this. And this is where Phoenix comes into play and this is where we're now going to come in, because we can offer a bank the full transparency. You don't have to rip out anything that you have. You can put a software layer on top of it. It's a client server architecture. You run it out in the background from your servers. You have very quick ways to update things and you provide one common interface. And when you talk about omni-channel, having multivendor capabilities is table stakes, otherwise you're limiting the target route that you can address as a financial institution.

[Matt Lipton:]

That's great. And then Chris, I had two questions for you. One, I know you probably don't want to disclose what the exact margin is on the Walmart business, but a lot of times people get into Diebold-Walmart the revenues look good, but the margins don't look as good. So can you at least frame in some context for us, what the profitability of that contract might look like?

[Christopher A. Chapman:]

Yeah, I would say, first and foremost it is a profitable deal and the margins that we're seeing on that are roughly in line on the hardware side with our historical national account business and then we also have a nice portion of this, which is part of our service business as well and those would run through I would say fairly well in line with our blended service margins as well. So overall a very nice add for us.

[Matt Lipton:]

Okay, thank you for that. And finally from me, the $0.10 guidance cut, when I look at what you'd change for Brazil and FX in your assumption, I think it's only a few pennies. So could you just walk me through kind of the delta between that and the full $0.10 change that you made this quarter? Thank you.

[Christopher A. Chapman:]

Yeah. If you bring the pieces together, so the 1% change in currency, just call that $30 million and with a 15% drop rate, net income before tax, you're looking at an approximate – call that about $0.05. And so that's the currency impact change in guidance. And then you look at the other piece of that movement and that's attributable to the change in our outlook for the Brazil markets, that's the breakdown of the $0.10, really 50

[Matt Lipton:]

Thanks guys.

[Operator:]

And we'll take our next question from Kartik Mehta with Northcoast Research.

[Kartik Mehta:]

Hey, good morning. Andy, I wanted to ask you about the sustainability of the gross margins. Impressive gross margins on both hardware and services. And as you move forward, do you anticipate – is this sustainable? Or are there some one-time issues that allow you to kind of get to where you are?

[Andreas Walter Mattes:]

Well, Kartik, the way you want to think about it is you always have seasonality in each quarter. You have deal mixes in each quarter. Every quarter where we have a huge hardware deal in it, for instance, puts pressure on the overall margins. But in general just rule of thumb. If you think about the industry, on the hardware side you're usually facing a 5%ish type of headwind and your design to cost efforts have to make sure that you get your arms around it. Going to a next gen hardware platform and rolling that out, that was a major step forward for Diebold. On the service side, you usually have about a 1% to 2% cost headwind in each geography and there you got to drive your efficiencies through service utilization, higher degree of automation, and higher degree of remote service capabilities, and that's right in the wheelhouse of what we're trying to accomplish with our IT upgrades. So business can always be seasonal, business can always have ups and downs, but we've got solid plans on how we're going to work on the sustainability on our gross margins.

[Kartik Mehta:]

And then as you look at the EMEA region, obviously based on the revenue growth you had, you probably had some market share wins. I know it's only the first quarter, so you don't want to get carried away there. But what is specifically driving that? Now I know the base is small, but what is specifically driving your ability to gain market share in that region?

[Andreas Walter Mattes:]

We have a very targeted approach. And if you think about Europe it was basically a market that was divided up between two of our main competitors and when a third, more innovative party enters the picture and gives the customer more attention, more agility and more flexibility combined with latest day technology, customers listen and we're having a lot of very interesting conversations right now.

[Kartik Mehta:]

And then just one last question Andy. You talked about obviously what Walmart is doing and then you made reference about other retailers. Is that just your thought that as other retailers witness what Walmart is doing, they'll want to do it or is that more of a commentary that you're having discussions with other retailers that are looking to provide some financial services for their customers and then there lies the opportunity?

[Andreas Walter Mattes:]

Actually Kartik you want to think about it on a little higher level. As banks are going through their evaluation, how many branches should I have? Where should I have a branch? The real estate in the groceries, in the supermarkets become extremely valuable, so you have two trends. You have companies like Walmart who want to embrace the population and in many cases the under bank population, which in the U.S. is a much bigger number than people would normally think of. And by the same token you have a lot of banks. I am aware of two major RFPs globally right now where banks are really interested in putting kiosks into the retail space to attract the customers right there and then, so this is going to be a very important piece of the puzzle as people think through how to provide financial services as an infrastructure to the respective population in each country.

[Kartik Mehta:]

Thank you very much, Andy. I appreciate it.

[Operator:]

We'll take our next question from Meghna Ladha with Susquehanna.

[Meghna B. Ladha:]

Hi. Thanks for taking my questions. What was the EPS or what is the EPS accretion from the Phoenix acquisition embedded in your fiscal 2015 guidance?

[Christopher A. Chapman:]

It's neutral this year, Meghna, just given some of our integration costs, and some of that loss in the top line from the purchase accounting, so no impact to EPS in 2015.

[Meghna B. Ladha:]

Okay. And then maybe if you can talk a little bit about branch transformation. I remember last quarter you all talked about expecting 20% growth in branch transformation this year and could we see an upside to this number?

[Andreas Walter Mattes:]

Meghna, first things first. There is still no definition out there in the market what branch transformation, or how we want to think about it, branch automation really all entail. From what we know leading market research companies are pretty close to coming up with a definition. And if we read the tea leaves properly at the moment, we're extremely well positioned, it's a very solid growth number. And I'd say definitely north of 20%. But I want to refrain from giving an exact number until we have a clear definition of what the starting point is. And I referenced Walmart earlier. That's a great example. It's a very big deal. Is that in or out? It clearly has all the technical functionality of branch automation, it just does not happen to fit in a physical branch, it fits in a retail floor space. So these are the type of things where the industry has to get its arms around. I would summarize it on a higher level, and say, financial services are transforming, financial services are being more automated, and that's cash, and noncash. If you take for example the work that we've done UBS in Switzerland, which was a competitive win for us that's where – the bank really went out by saying we want to automate the noncash functionality in a branch like account openings. You can actually walk up to a kiosk, do all your data and get your bank card within a few minutes after you're doing this thing, right there and then, and use it five minutes later down mainstream in a store as a debit card. So tons of opportunity, still lack of definition, lots of interest, very opportunity rich from a growth point of view.

[Meghna B. Ladha:]

Thanks, Andy. That's helpful. And with regarding the Venezuela business, correct me if I am wrong, but you saw the same issue I believe last year as well. So can you help us understand, why, or what led you all to exit the business now?

[Andreas Walter Mattes:]

Let me start out with a flip comment and I'll let Chris take it from there. But from a business point of view, Venezuela has basically left the building. There is no rational way for us as management to get our arms around a country where you have absolutely no access to your currency and the currency itself is artificially being lowered in very short intervals. But I'll let Chris give you the more financially savvy answer on that one.

[Christopher A. Chapman:]

And when you look at this from our treatment in 2014, if you think about it 2012-2013, there were various movements in the bolivar and we were subject to those currency fluctuations when we were in the business and we were in the market. And so when we saw the devaluation occur last year, while it was substantial, and sizable, we were still in the location and we were still subject to those moves when you looked historically. When you think about it on a go forward basis with our decision to exit the business like several others have done and taken this treatment. You can look at Ford and some others that have taken pretty significant actions in Venezuela. We really viewed it from a forward-looking standpoint. The volatility and the impact of Venezuela, as you compare our results moving forward, are not going to be there, because we've changed the model. And so we thought it was prudent to remove that from our non-GAAP in 2015, because that's going to be more relevant when you compare us on a quarterly basis moving forward into 2016 and beyond.

[Andreas Walter Mattes:]

Now having said all of that the indirect model gives us the opportunity to continue to service our customers. There is a few really large international banks that have representation in Venezuela. We have the majority of the market share down there and this way we can make sure our customers are not left stranded because of political idiosyncrasy.

[Meghna B. Ladha:]

Okay, thanks Andy. Just a very quick follow-up to Chris on my first question. You said that the Phoenix EPS accretion is neutral, but isn't that neutral inclusive of integration cost, so wouldn't you back out the integration costs. I'm just trying to figure out what the non-GAAP EPS accretion from Phoenix?

[Christopher A. Chapman:]

Yeah. The integration costs are included both in our GAAP and non-GAAP numbers. We're not going to try to call out the integration costs of the Phoenix. It's not going to be extremely significant and we're really trying to get in a habit of keeping those non-GAAP adjustments to a minimum around the restructuring, legal costs, and real significant events. We're not trying to get every little item into the non-GAAP line.

[Meghna B. Ladha:]

Thank you.

[Operator:]

And we'll take our next question from Justin Bergner with Gabelli & Company.

[Justin L. Bergner:]

Strong top-line result.

[Andreas Walter Mattes:]

Sorry Justin, we missed the first half of your comment there, it cut out. Could you repeat?

[Justin L. Bergner:]

I just said, good morning Andy and Chris. Congratulations on the strong top-line result. Can you hear me better?

[Andreas Walter Mattes:]

Yes.

[Christopher A. Chapman:]

Yes, thank you.

[Justin L. Bergner:]

Okay. Great, a few quick questions. In Europe, obviously one of your competitors had a meaningful negative preannouncement and sort of made it seem like the market was worsening. In light of your strong performance in Europe, are you seeing deceleration in the market or is the market sort of showing stable growth?

[Andreas Walter Mattes:]

Well, just let's be fair. We're talking EMEA here and there are stories within the story, and our footprint is clearly helping us. We have little to no exposure to Russia, for instance, and the adjacent states. The second thing is we are taking a targeted account view. So even within economies that might be under pressure, there is always one or two banks that are very healthy, that are very good business partners, and that you like to be engaged with. And that's our criteria as we go around Europe. And then of course you add to it the amount of dedication, the amount of service, the amount of innovation. If you take a look for instance at our Brussels Innovation Center, it's a huge asset for our European team to be able to design customized solutions, be more nimble. Think of it as the Pininfarina of the ATM industry. So we got some really cool assets there. We are very diligent in our approach and we're very optimistic, especially with our services led approach, about our European expansion.

[Justin L. Bergner:]

Good to hear. With respect to the Walmart order, how much did that add to your total order book in this quarter, or your total financial self-service order book, if you can quantify?

[Andreas Walter Mattes:]

Well, for those of you who know Walmart, you're never at liberty to disclose any numbers. But before you start modeling this thing out, this is a really long managed services deal. So it's a very high TCV number, but it's going to monetize over multiple years and the services pieces are not booked in one lump sum as you very well know. There is no such thing as services backlog. They're being booked pro rata as you perform these services, so we'll be enjoying the benefits of that for many years to come.

[Justin L. Bergner:]

Okay, thank you. But it is a meaningful contribution to that plus 10% constant currency order number, it's safe to assume?

[Andreas Walter Mattes:]

It is safe to assume and it's a meaningful contribution to the plus $100 million TCV number that I gave earlier.

[Justin L. Bergner:]

Okay, thank you. With respect to free cash flow, you maintain your free cash flow guidance of $100 million to $120 million. Is there an offset to the lower EPS guidance that's allowing you to maintaining that free cash flow guidance, or do you just not think it was material enough to lower the guidance range for free cash flow?

[Christopher A. Chapman:]

I would say it a little bit differently. When we gave the original guidance of $120 million we were trying to be inclusive of a lot of the overall programs that we have in place. We feel very good about our focus on working capital and cash and based on the momentum that we have globally in that program, we feel we have the ability to still meet the original guidance of approximately $120 million.

[Justin L. Bergner:]

Okay, great. And then just really quickly, the one-time charges in your annual guidance for the adjusted EPS, I guess, are now materially larger, but just seems like the difference relates to the software impairment charge in Venezuela. Is that correct or are there other differences too, besides your old and new guidance as it relates to the one-time adjustments?

[Christopher A. Chapman:]

Yeah, you basically have it correct. So if you look at the breakdown there, you've got the $0.09 for the software impairment, you've got the $0.15 tied to Venezuela, the legal costs are in a $0.10 to $0.13 range. And then restructuring has been increased slightly, up $0.02, and it's now $0.07 to $0.09 for the full year is the breakdown of all of the pieces there.

[Justin L. Bergner:]

Great, thank you for taking all my questions. Best of luck.

[Christopher A. Chapman:]

Thanks, Justin.

[Andreas Walter Mattes:]

Thanks.

[Operator:]

We'll take our next question from Saliq Khan with Imperial Capital.

[Saliq Jamil Khan:]

Great. Thank you. Good morning, guys. I'm speaking on behalf of Jeff Kessler as well along with myself. We just had a couple of quick questions for you. First one being is that while we see that EMEA grew double digits on a constant currency basis, we did notice that APAC was growing at low single digits. Given this, could we particularly, could we expect some sort of reshuffling of the leaders of the APAC to help you further grow this region.

[Andreas Walter Mattes:]

I'm not quite sure I fully understood the question, would you mind rephrasing?

[Saliq Jamil Khan:]

Sure, essentially what we're saying is that we're seeing a robust amount of growth coming out of the EMEA region, but not necessarily from APAC on a constant currency basis. Could I expect some sort of a reshuffling of the leaders to the APAC region from either EMEA, or North America, or elsewhere, or the hiring of additional leaders from your competitors to help you further grow that region?

[Andreas Walter Mattes:]

Well, Asia Pac is a beast of many colors. What you got to balance in your views and in your models is there is a lot of opportunity in Asia, in India, all across ASEAN, Australia-New Zealand. But by the same token, the political headwinds that all western manufacturers face in China are very real. There is a clear direction from the government to embrace local technology. So the Chinese market will become more contested with local players, and that is going, given its size and magnitude, that's going to impact the size of the addressable market for the western players.

[Saliq Jamil Khan:]

Okay. The other one being is that – it's been asked several times already regarding Walmart and the deployment itself. I'm not necessarily concerned about this being a four-year to five-year contract win, but what I do want to know is that how do you essentially approach this contract to be able to maximize cost efficiencies going forward?

[Andreas Walter Mattes:]

The best way to make money in a managed service contract is, A, to have a very good detailed contract with very clear SLAs, so both parties know exactly what they're signing up for. And those of you who know Walmart know how diligent that company is in defining their requirements. B, is to make sure that internally you got all your systems and your controls set up properly to deliver to that SLA. And C, then is flawless execution over the term of the contract. And we've done all of this. This has been a project in the making for many, many, many months. Those of you who've heard me talk about managed services deals, I've always told you that those have 12-month, 18-month, and in some cases even 24 month lead time, because the devil is in the detail. This is a good example of a well-thought out process over a long period of time that all participants feel very comfortable with.

[Saliq Jamil Khan:]

Okay. Andy, the last question I have for you as well, surrounding Walmart again. Is that – while Walmart is pretty secretive about the contract details, one of the good things about winning this contract is that you have a lot of the other top 10, top 15 and top 20 retailers looking at you and coming at you as well. So how do we think about more such contracts particularly in the U.S. over the next 12 months to 18 months?

[Andreas Walter Mattes:]

Well, look, this is a great question. I would say this is, it's unchartered territory. You won't find it in a market research report, which makes it so exciting and you're absolutely correct there is a lot of interest and we're already starting to get a lot of inquiries from other players. We'll have to see how this thing is going to play out.

[Saliq Jamil Khan:]

Great. Thank you guys. I appreciate it.

[Operator:]

And we'll take our next question from Vignesh Murali with Sidoti & Company.

[Vignesh Murali:]

Hey guys, thank you for taking my question. First question is on capital allocation priorities for the rest of the year. Are acquisitions still near the top of the list? And if they are, is it more likely going to be in the security side or the financial services side?

[Andreas Walter Mattes:]

I think what we've talked about before with regards to hitting the second half of that question is our focus would probably be more on the software and services side from an acquisition standpoint. If you look at what our capacity is, we still do have sufficient capacity on our balance sheet to go out after additional, what I would call, tuck-in acquisitions. So feel good about where we're at and our capacity to continue to focus more on that growth side as we continue to move forward.

[Vignesh Murali:]

Great, thank you for that. And as a follow-up, on the electronic security side, what are the major drivers behind the continued strong performance of that segment and also can you provide an update on like the progress made by the SecureStat platform in terms of market share?

[Andreas Walter Mattes:]

Absolutely. This is clearly a we try harder approach. We are a very distant number three. We only focus on national and large regional accounts and you've already mentioned our secret sauce. The ability to have the SecureStat layer, which you can basically think of as a portal on any existing security infrastructure is very, very important for us to gain share. Again it's the concept of embracing heterogeneous environments, because what it enables a customer is to switch, for instance, their video monitoring over to Diebold without having to exchange a single camera, or without having to exchange a single keypad at the door. All you do is you roll out SecureStat and then you can connect with the Diebold remote center. And now with our partnership with Eagle Eye, you can actually also do the whole thing in the cloud, which will give you yet more flexibility. So we're rolling out SecureStat with just about every one of our wins that we are picking up these days.

[Vignesh Murali:]

Great, thank you for the color. That's it from me guys, congrats on the quarter.

[Andreas Walter Mattes:]

Thank you.

[Christopher A. Chapman:]

Thanks.

[Operator:]

And we have no further questions in queue at this time. I would now like to turn the conference back over to our speakers for any additional or closing remarks.

[John D. Kristoff:]

Thank you Kyle and thank you everyone, for joining our call today. As always feel free to reach out to myself or Steve with any follow-up questions. Thanks again.

[Operator:]

This does conclude today's conference call. Thank you all for your participation and you may now disconnect.