Diebold Nixdorf, Incorporated
Q3 2015 Earnings Call Transcript

Published: 29 Oct 2015

[Operator:]

Good day, everyone. Welcome to the Diebold, Incorporated's Third Quarter 2015 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Steve Virostek. Please go ahead.

[Stephen A. Virostek:]

Thank you, Hannah. I'd like to welcome everyone who's joining us today for Diebold's third quarter earnings call. Joining me today are Andy Mattes, President and Chief Executive Officer; and Chris Chapman, Senior Vice President and Chief Financial Officer. In addition to our earnings release issued this morning, we've posted presentation slides on the IR page of diebold.com. We will be referencing the presentation during our commentary and we encourage you to follow along. Today's webcast is being recorded and a replay of the webcast will be made available later today on deibold.com. On slide two of our presentation, we disclosed that we'll be making references to non-GAAP financial information on this webcast. Consistent with the company's prior practice, we exclude restructuring charges and certain non-routine expenses from our non-GAAP financial metrics. We believe that these non-GAAP metrics provide a helpful indicator of the company's baseline performance. And a reconciliation of GAAP to non-GAAP metrics is included in the supplemental materials at the end of today's presentation. Moving to the slide number three, I'll remind you that certain comments made during our webcast may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. These statements involve a number of factors that could cause actual results to differ materially from these statements. Additional information concerning these factors is contained in the company's filings with the Securities and Exchange Commission. Please keep in mind that the information discussed is only current as of today and subsequent events may render the information in this webcast out of date. I'm sure many of the participants are aware that on October 17, Diebold announced that the company had entered into a non-binding term sheet agreement with Wincor Nixdorf regarding the key parameters of a potential strategic business combination. Entering into a transaction is still subject to material conditions, including the satisfactory completion of due diligence by both parties. There can be no assurance that any binding agreement will be reached or that a public tender offer will be launched. Diebold will have no further comments on any potential combination during today's webcast or until a binding agreement is reached or the discussions are terminated. And now, I'd like to hand the call to Andy Mattes.

[Andreas Walter Mattes:]

Good morning and thank you for joining us. As you can see from our recent announcements, we've had quite a busy summer. Our portfolio-shaping actions demonstrate that we have fully arrived in the walk phase of our transformation. I will discuss these developments and speak to our third quarter operating highlights before handing the call to Chris. This week, we announced the divestiture of the North American electronic security business for $350 million in cash to Securitas, an $8 billion global leader in security services. The electronic security business provides access control, video surveillance, intrusion and fire protection solutions, along with system design, installation, monitoring, and security-related managed services. The transaction achieves three business objectives. First, it places our electronic security customers in the very good hands of a larger company fully focused on delivering security solutions, which will bring significant resources to enhance and grow this business. Second, the transaction sharpens our focus on the dynamic self-service industry and on the terrific growth opportunities which we are pursuing in the areas of branch automation and omni-channel. Third, it provides a source of capital for ramping up these activities and building up intellectual property necessary to deliver transformative solutions to our customers. As an example of these activities, the company introduced two new concept solutions at the Money 20/20 show in Las Vegas just a few days ago. The first concept combines consumer recognition technology and a secure mobile phone app to execute cardless transactions. The second concept is a dual-sided sell-service terminal which features video teller access and is capable of serving two customers simultaneously. Going back to the divestiture, carve-outs don't materialize overnight because they require a lot of preparation. We have outlined a detailed transition plan which is designed to deliver a seamless experience for our electronic security customers. The transition to Securitas benefits from the fact that this business has its own IT platform, sales force, installers, technicians, and monitoring facility. The companies have also agreed to a strategic business alliance in which Securitas would become Diebold's preferred supplier for electronic security and Diebold will become the preferred supplier for Securitas in all areas relating to self-service. Importantly, the companies have agreed to collaborate on enhanced service offerings for our customers. Irrespective of this divestiture, ATM-related security is a key differentiator for Diebold in the market as demonstrated by innovative solutions such as our ActivEdge anti-skimming solution, Cryptera PIN pad encryption technology, and GAS logical security software. We have long been the leader in self-service biometric identification in the Western world and we're taking our leadership capabilities to the next level by piloting an iris-scanning ATM concept with Citigroup as featured on The TODAY Show earlier this week. This is a prime example of Diebold's collaborative innovation approach with our customers. In support of our services-led strategy, we are retaining our physical security business which generated approximately $230 million of revenue over the last 12 months. Nearly 80% of the business is services-related. We are maintaining the physical assets of our customers, which includes safe deposit boxes, vaults, vestibules, after-hour depositories, and drive-up solutions. These skill sets are important enablers for connecting the physical and digital worlds of cash and they would benefit our self-service business in the area of branch transformation and next gen video-enabled drive-ups. Now, let's turn to Q3 results. The company delivered $0.36 of EPS on a non-GAAP basis. For our full year outlook, we are narrowing our non-GAAP EPS range from $1.70 to $1.90 to a range of $1.75 to $1.85. Chris will walk you through the puts and takes during his remarks. In general, we delivered good operational performance around globe. However, the political and economic environment in China and Brazil is weighing on our results. In China, we are working towards a longer-term solution and expect to be able to discuss a new approach going into 2016. In Brazil, we are narrowing the scope of our Brazil other business by eliminating large IT equipment government contracts from the mix, thereby containing downsized exposure. Earlier this year, Brazil was rolled out into Latin America under the leadership of Octavio Marquez, who upgraded the country manager, adjusted our fixed cost structure, and aligned the business with market reality. Turning to total global orders, we continue to see the effects of the strong U.S. dollar in the third quarter. In aggregate, orders were down 7%, as reported, but increased 1% in constant currency. Excluding China, orders were up high-single digit in constant currency. My regional comments will focus on FSS orders. In North America, orders grew by 4% year-on-year led by strong demand from the national players and increasing volumes of our new family of ATMs. We're seeing a good take rate following several months of customer collaboration and education with respect to the increased functionality and lower total cost of ownership of the new line of ATMs. It is encouraging to see that our services-led strategy continues to gain traction. For example, in North America, we secured a multi-year contract with Wells Fargo to service more than 6,000 non-Diebold ATMs. Wells is one of the top three banks in the United States and it's good to be back in this account in a meaningful way. This is the fourth major multi-vendor services win in North America alone this year and we have added more than 11,000 non-Diebold ATMs to our contract base. The other good news is that branch transformation continues to take hold across financial institutions of all sizes. For example, we deployed our first two-way video solution at Affinity Credit Union in Canada using the 9,900 in-lobby teller ATMs. We also launched our Mobile Cash Access software at ALMA Bank in New York, which facilitates cardless transactions via mobile phone. And in Louisiana, we secured a contract with IBERIABANK to upgrade nearly their entire fleet with ActivEdge anti-skimming card readers. Developing, testing and introducing these innovations and transformative solutions is no small undertaking. We invest millions of dollars in R&D to bring these innovations to market. So it should be no surprise to anyone when we take strong action to protect our intellectual property as we have done with the Hyosung. Turning to EMEA, orders were up more than 20% in constant currency, led by significant wins in the UK, France, Turkey, and the African nations. These wins were also spurred on by the new family of ATMs and our account-focused approach. For example, in Saudi Arabia, we received a new product order from Riyad Bank for 100 new 5500 series ATMs. We're doubling down on the Middle East, and we recently opened up a new office in Dubai. We look forward to delivering our innovative branch automation solutions to customers in that geography. On a lighter note and in the spirit of Halloween, we also just secured a competitive win in Romania with Transilvania Bank. Moving onto the Asia-Pacific region, orders were overshadowed by the Chinese government's buy local initiative, which led to sizable reduction in total product orders. Services in China, by contrast, are doing well, and we reported 2% growth in the quarter and 12% growth year-to-date. In Latin America, we delivered another very strong quarter as orders increased more than 20% in constant currency, boosted by strength in Mexico, Ecuador and across the region. In Brazil, we won a new contract for 400 deposit automation ATMs with Bradesco, the second-largest private bank in that country. This win demonstrates Diebold's ability to bring innovation to the market, and it is our first significant win in that account since they formed an alliance with a competitor of ours four years ago. We also signed a $20 million, five-year managed service contract with a top bank in Mexico following our Q2 win to install 2,200 ATMs with the ActivEdge anti-skimming card reader. This outsourcing contract, when combined with other services-led wins in the Americas and in Europe, enabled the company to break through the $300 million mark for total contract value thus far in 2015. As you can see, Diebold's transformation towards a services-led, software-enabled company is starting to manifest itself into our contracts. Along these lines, expanding the installed base that we are servicing is another avenue towards this goal. We recently announced that the company had entered into a non-binding term sheet agreement with Wincor Nixdorf regarding the key parameters of a potential strategic business combination. We are currently working our way through the diligent process. As Steve said in his introduction, there can be no assurance that we will reach a binding agreement and we cannot comment further at this time. In conclusion, we continue to make significant progress in the walk phase of the Diebold 2.0 transformation. By reshaping our portfolio of businesses, we are sharpening our focus on our self-service customers. It is our mission to move up the value chain and become the strategic partner for financial institutions and retailers around the world. We're moving closer to our goal of becoming a services-led, software-enabled company. And now, Chris will discuss the financial details.

[Christopher A. Chapman:]

Thanks, Andy, and good morning, everyone. I will start off by walking through our third quarter financial performance and then provide an update on our 2015 outlook. Starting on slide nine, in the third quarter, total revenue as reported was down 11% compared to prior year and down 3% in constant currency. The main drivers of the year-over-year change in the third quarter were significantly lower volume in our Brazil other business, currency headwinds from the weakening of the real and slower product sales in China. Our Latin America region, excluding Brazil other, delivered solid constant currency revenue growth of approximately 28%, driven by strong delivery of product in the financial self-service business. Additionally, EMEA revenue grew more than 7% in constant currency as services growth outpaced product growth. Finally, North America increased approximately 1% in constant currency in the quarter while Asia-Pacific decreased 16% adjusted for currency. As you can see on our slides, currency continues to have a significant impact on our 2015 results. In the quarter, currency headwinds negatively impacted total revenue by approximately 9%. As we move to slide 10, financial self-service revenue decreased approximately 7% as reported. On a constant currency basis, revenue grew 1% versus the prior year period led by growth in our services business. Revenue in Asia-Pacific declined by approximately 13% in constant currency, primarily due to a decrease in product revenue resulting from the Chinese government's buy local initiative. North America revenue decreased approximately 4% in constant currency as higher national account activity partially offset the spin from regional banks, which declined following strong Windows 7 upgrade activity in the prior year. In EMEA, we delivered constant currency growth of 7% led by solid contributions from both product and service. In Latin America, we reported nearly 26% growth adjusting for currency driven by broad-based growth including Brazil from the increasing sales of our new family of ATMs. Total security revenue on slide 11 increased approximately 5%, or 7% in constant currency. Electronic security continues its solid performance with revenue increasing approximately 9%, or 12% in constant currency, as we prepare to transition the North America portion of this business to its new owner, Securitas. Revenue from our physical security business was down approximately 2% year-over-year as this business is beginning to stabilize. Looking at slide 12, Brazil other declined approximately $54 million year-over-year as we delivered on a large lottery contract in the third quarter last year. On slide 13, total gross margin decreased 130 basis points to 24.9% on a non-GAAP basis. Service margin increased 10 basis points as we continue to benefit from our efforts to improve the mix of revenue and grow our Services business. The product gross margin decreased 460 basis points to 16.6%. This was primarily due to lower volume in our Brazil other business and the adverse impact of a $4.7 million inventory write-down related to the cancellation of two local government IT equipment projects in Brazil. As Andy described, we are narrowing the scope of the Brazil other business to focus primarily on lottery and election systems. Moving on to slide 14, total operating expense was 20.2% of revenue compared with 19.5% in the prior-year period with overall spin down $12 million, net of a $4.6 million bad debt reserve. This overall operating expense reduction is an indication that reinvestments are beginning to ease in the second half of 2015. The bad debt reserve is related to the cancellation of a previously awarded government contract for IT equipment in Brazil other. Turning to slide 15, we have realized approximately $70 million in net cost savings since the program's beginning. We had reinvestments year-to-date in 2015 of $16 million and still expect approximately $20 million in reinvestments for the full year. As we have discussed on previous calls, the vast majority of our reinvestments are hitting an operating expense while approximately two-thirds of the savings come through in the gross profit line. For the year, 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. Turning to slide 16, non-GAAP operating profit decreased approximately $20 million from the prior year and our operating margin was 4.6% due to lower volume in China and Brazil, the cancelled IT equipment project in Brazil other of $9.3 million and reflected FX headwinds. Looking at operating profit as reported by segment on slide 17, North America decreased $4.5 million versus the prior year, driven by the increasing mix of national account business. Asia-Pacific decreased $6.6 million as a result of lower product volume in China. EMEA decreased $3.3 million due to the impact of currency and mix of business across the region. In Latin America, operating profit decreased by $13.9 million driven by Brazil other and FX headwinds. The global and corporate line improved by $8.6 million reflecting our cost actions in addition to our reinvestments beginning to ease. As noted in the previous quarter calls, we have been taking action to control our spend and pace our reinvestments to help offset some of the headwinds I discussed earlier. Turning to the EPS reconciliation on slide 18. Non-GAAP EPS was $0.36 for the quarter which was in line with our commentary that we provided on the previous earnings call. Non-GAAP EPS excludes restructuring charges of $0.08; legal, indemnification and professional fees of $0.02; $0.03 related to acquisition and divestiture fees; and a benefit of $0.10 primarily related to the allocation of discrete tax items in accordance with our non-GAAP tax-rate procedures. During the quarter, the non-GAAP effective tax rate came in at 13.4% and is 23.2% on a year-to-date basis. The decrease is attributable to the repatriation of foreign earnings and the associated recognition of foreign tax credits. Moving on to free cash flow on slide 19. Our results from the quarter reflect a $38 million free cash use, which is unfavorable approximately $4 million from the same period last year. This is primarily due to a change in working capital. On a positive note, we've launched several pieces of our new Oracle platform in North America, providing enhanced visibility and efficiency as we replace our 30-plus-year-old systems. As with any software implementation, there is always a cutover period that can cause delays. In our case, the transition to our new service contract system resulted in invoicing delays of approximately two weeks in September. As a result, collections were impacted by approximately $20 million for the quarter. Turning to slide 20. DSO reflected an increase of two days to 67 days in the quarter versus the same period last year, primarily due to the delayed service contract invoices for North America that I just discussed. Inventory turns improved, increasing to 5.2 turns compared with 4.4 in the third quarter 2014, reflecting lower volume in China and Brazil, as well as continued improvements in our global supply chain. Net debt, on slide 21, for the period was $402 million, an increase of $355 million from year-end 2014. The increase in net debt is largely attributable to the acquisition of Phoenix, continued adverse exchange rate impact on cash balances, as well as working capital expansion to support our business. Turning to slide 22. The company is narrowing its outlook for non-GAAP EPS to be in the range of $1.75 to $1.85 for the full year 2015. While there are a number of moving pieces at a high level, we are maintaining the midpoint of our previous EPS guidance. We have two significant negative impacts to EPS for the year since our previous guidance

[Operator:]

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

[Gil B. Luria:]

Yes. Thanks for taking my question. So you discussed the order growth in the quarter. On a constant currency basis, it still looks good. How about the TCV type metrics, the services contracts? How are those shaping up as compared to last quarter and last year?

[Andreas Walter Mattes:]

Gil, thanks for the question. Last year the number was anemic. We said we were around about 150 million-ish at our last call. We've set ourselves a target to be around about 200 million for the year, so we've blown through the target by quite a mile and the Wells contract is just an incredible add to the portfolio and, most importantly, it's an incredible verification of the strategy what we're taking. If you think about what that means and you translate that into your model, on average, these contracts are five-year contracts. So do the math, that's roughly $60 million per annum. Then you've got some runoff that you have from the previous year where the service business was positively impacted by some of the Win 7 upgrade. But net-net, you're looking at least at a $40 million-ish upside to our service revenue going into 2016 that's baked as of January 1. The other thing that was very encouraging, we told you about a very large services – multi-vendor services contract at the last call with another top three bank in the U.S. Between then and now, we've taken over that complete base. The whole park is up and running and we did not have one hiccup along the route. Both the customer as well as our teams have done a tremendous job, but we know we're onto something both from a sales, but what's also equally as important for the customer from a delivery point of view that we're able to delight our customers and grow our business.

[Gil B. Luria:]

Got it. And then in terms of the delta from last quarter and your revenue guidance, China and Brazil have been challenged and then you have currency. In terms of the change to guidance, how much of it is the shift in currency versus China and Brazil getting worse? Is the change in guidance entirely currency or have China and Brazil gotten worse than what we were talking about three months ago?

[Christopher A. Chapman:]

I think the short answer is its primarily just tied to the currency and so if you look at where we're at on the FSS basis, we're right in line on a fixed rate at approximately 6% growth for the full year.

[Gil B. Luria:]

And so then last thing on China and Brazil, just could you remind us of total revenue, how much do China and Brazil compromise – comprise – how much of revenue comprise of China and Brazil as of this year?

[Christopher A. Chapman:]

So for this year for China we're at approximately – it's approximately a $200 million business, is what we've talked about before. It's roughly about 40%, 45% of the total Asia-Pacific business and you should think of that probably weighted around 60% product, somewhere in the 60% range, then 40% on the service side. On Brazil, you know it's roughly a $300 million business, give or take.

[Gil B. Luria:]

Got it. Thank you very much.

[Operator:]

Next we'll go to Joe Radigan with KeyBanc.

[Joe K. Radigan:]

Thanks. Good morning, guys. First, a couple questions on Electronic Security divestiture. What will the tax impact be from the sale there? And will there be any hung overhead cost that will burden the rest of the P&L? And then maybe, Chris, maybe you can give a framework on how to think about the impact on 2016?

[Christopher A. Chapman:]

Yes. So let's just talk about the high-level pieces for the ES business. First of all, with regards to timing, the expectation is we're going to close, I would expect, in the January timeframe. We have to clear the typical regulatory hurdles and a couple of other pre-close items. When you think about it from a full year impact in 2015 first, it's roughly a $345 million business. That comes through – and again, this just a rough number, around 7.5% operating margin on that. From a calendarization standpoint, Q1 is usually the lowest quarter, and then it's pretty steady after that. Q2 through Q4 in this business, it's not as volatile as, or doesn't swing as widely as our FFS business does. And so if you think about that in order of magnitude, apply a pretty similar framework into 2016. And then with regards to stranded costs and some of the items that we're going to have to deal with, overall, this business has been fairly standalone for a while. We will have a handful of stranded costs that we will have to ultimately be deal with. But I think on the positive side, with the growth that we're seeing in our overall multi-vendor service activity, we're really going to be able to leverage the overall organization as we're growing in our services business in North America. Those are the high-level pieces, Joe.

[Joe K. Radigan:]

That's very helpful. Thank you. And then what happens to the Electronic Security business in Latin America? Is that still part of the long-term plan this year? And will you continue to report security as a separate segment going forward into next year once the North American ES business is gone?

[Andreas Walter Mattes:]

Let me start with the business. The Electronic Security business that we have in LatAm, as well as in Asia, predominantly in India, will be part of our go-forward operations and it will be primarily part of our service organization and our service numbers in those countries. And I'll let Chris talk to the reporting.

[Christopher A. Chapman:]

Yeah. With regards to the segment, we will clarify that in the first half of 2016. The initial thought as of now is the security business is going to be broken out as is through our 10-K and then we will definite how we want to handle that with our 10-Q in the first quarter of 2016.

[Joe K. Radigan:]

Okay. And then the last question. You mentioned you got a win at Bradesco. I mean that used to be a pretty significant account for you guys. So is this an indication of possibly more positive things to come or can you talk about the kind of the moving pieces around that?

[Andreas Walter Mattes:]

We think it is indicative of a few things. First, in a country that has enough political turmoil, winning with private banks, very, very important. Secondly, as you know, they've done a joint venture with our competitors, so we were not in the account in a meaningful way for the last years. And the third thing which is really the most exciting is in the last go-around they had a – they bid out, they turned to Diebold for their high-end machines, fully-loaded, highest software content, the most complicated solution, the most value-add to the customer went to Diebold. And we're super excited about that and, yes, we do see that as a springboard going forward.

[Joe K. Radigan:]

Great. Thank you, guys.

[Operator:]

Next we'll go to Saliq Khan with Imperial Capital.

[Saliq Jamil Khan:]

Thank you. Hi, Andy.

[Andreas Walter Mattes:]

Hi.

[Saliq Jamil Khan:]

As you're looking at the Electronics Security divestiture, it certainly does increase the overall focus on financial self-service, but it was growing at double the rate of the overall industry. How did you and your team weigh the costs and benefits when making the decision?

[Andreas Walter Mattes:]

That's a great question, Saliq. You see it's a great business. We grew the business organically and we outgrew the market basically for as long as I've been with the company. But for me it's a little bit like raising a kid, taking it all the way through high school, it gets great scores and now it's time for the kid to go to a great college. There's only so much you can do in this space organically, and we think the business, given its drive and its assets, deserves an even brighter future, and we're looking for a way to continue to outgrow the industry and most importantly also to make sure that our customers will continue to benefit from innovation in the security space. And when two parts of your business are in a market that's fundamentally transforming, the electronic security market is transforming in its own rate as well as the self-service market, and you've got to ask yourself how much capacity do you have? How much attention can you give to two fundamental transformations? And then our thought was we've got to double down on the core business of the company and we need to make sure that Tony Byerly and his team, who've done an incredibly great job, will have an even brighter future and our customers have even better innovations going forward.

[Saliq Jamil Khan:]

Now if you look at the remaining portions of security, which is physical security going forward, it has been slow growing versus the Electronic Security. How do you reverse the trend that we've seen over the last several quarters of physical security not growing at the rate that you wish it did?

[Andreas Walter Mattes:]

Well, you've been kind. It's actually been shrinking for the last years and – but the big thing is the rate of decline has come down dramatically and it's providing a very stable floor to our service organization. As I said on the call, about 80% of that business is service, and by the way it's all in branches for financial customers. And here's the flip side

[Saliq Jamil Khan:]

Andy, just one last question for you, then I'll hop back in the queue. As you've announced the partnership with Citigroup when it came to the iris-scanning ATMs, to be able to better reduce the overall cash withdrawal time to around 10 seconds or so, within your research, do you believe that the end-user will be willing to, A, submit the biometrics, but on the other hand, what security measures will be put in place to secure the biometrics once they have been submitted?

[Andreas Walter Mattes:]

There's – that can be a long conversation. So let me just rephrase this. In the U.S. we currently have a very skeptical consumer attitude towards biometrics. But we've seen in other parts of the world where biometrics are a standard already today. Think about palm readers, fingerprints, what have you not. When crime and insecurity becomes more topical for consumers, the question is – you change your weighting on

[Saliq Jamil Khan:]

Great. Thank you, Andy.

[Operator:]

Next we'll go to Joan Tong with Sidoti & Company.

[Joan K. Tong:]

Good morning, guys. I have a question regarding like the multi-vendor service business. Obviously, you've done a great job another $150 million in contracts during the quarter. And just want to see if you can give us like a high level, how you think about like maybe 2016? What's really in the pipeline? The pipeline profile? How should we think about it going forward and then the growth rate and all that?

[Andreas Walter Mattes:]

That's a great question. I can tell you the pipeline is expanding on all levels

[Joan K. Tong:]

Okay. What is the rationale behind keeping the rest of the Brazil other business and it obviously is a business that would continue to fluctuate from year-to-year, quarter-to-quarter, just want to see would that be more strategic business realignment to maybe get rid of the rest of the Brazil other business?

[Andreas Walter Mattes:]

Look, just because business is lumpy doesn't mean a business is bad. As long as it comes in as predicted and it comes in with good margins. The issue we had in Brazil is that previous management got hooked on the drug of doing other deals so bad that they forgot to run a good book of business in our core business, and that's what we're changing. So first order of business is we're going to run a profitable, accretive business in our core FSS business and then we're taking lottery and voting when and if these businesses occur as upsides to our forecast and not as the lifeline that we need to justify the P&L and the cost structure of a country. The other site, don't underestimate all these machines, they're not that dissimilar to an ATM, needs service. We've got a huge service force in Brazil. And back to your initial question, whenever you can service more, can – you – drive utilization up, your service margins will increase. And given the density especially of the lottery machines around the country, this is a great way to continue to improve Brazil's service margin. And third, the lottery is run by Caixa, which is a government-owned agency, which also happens to be the largest or second-largest bank in the country, which is also our largest customer on the banking side, so we're actually re-using the same customer relationships as we go forward.

[Christopher A. Chapman:]

And I wanted to add just one additional point here as well. I misspoke earlier on the total Brazil revenue. So if you think about the current Brazil business, it's roughly $200 million, not $300 million that I mentioned, with about $20 million of that in the Brazil other for the current year.

[Joan K. Tong:]

Okay. All right. That's fine. And then, finally, the question regarding your hardware business. Just want to get a sense of the competitive landscape and also pricing, like any major pricing pressure or any heightened pricing pressure that we have seen in the past couple of quarters. Thank you.

[Andreas Walter Mattes:]

First of all, competitive landscape is increasing dramatically. Just think about what branch transformation does. It changes all the processes in a branch. So self-service providers all of a sudden are being faced with competition from behind-the-counter technology providers, are faced with competition from the cash-in-transit providers. And around all of that, you've got the big gorillas. You got the banking softwares, the IBMs and SAPs and Oracles on the one side, and you've got the Visa, MasterCard as the largest payment structures on the other side. So competition, definitely increasing, new players – a new geographic mix of players. The Asians, the Koreans, the Japanese, the Chinese are moving into every market in the world, and hardware will continue to commoditize. We've said earlier, and we continue to say, that we believe hardware has about a 5% price pressure on its margins. And we see very competitive pricing in the market. And we also see some of our established competitors to get a little bit more nervous and putting a lot of pressure on pricing out there.

[Joan K. Tong:]

Thanks for the update. Thank you.

[Andreas Walter Mattes:]

Thank you.

[Operator:]

And we'll go next to Matt Summerville with Alembic Global Advisors.

[Matt J. Summerville:]

Hey. Good morning. A couple things. First, I want to talk about Brazil a little bit more. If I look at slide 17, your Latin America profitability, both in the quarter and year-over-year, I have to conclude you're losing a bit of money in Brazil. Probably not a small amount, although smaller given what the currency has done. So I really want to understand what you're doing to make this business profitable going forward and whether or not there's incremental cost actions that you're evaluating or are under way now. And if that's the case, why not raise the cost-out bar that you've set? And then I have a follow-up.

[Christopher A. Chapman:]

Yeah. Let me first just address the profitability in the quarter. And so we've talked about the $9.3 million write-off that we had. Excluding that impact of that $9.3 million write-off, Brazil would have been profitable in the quarter. On a year-over-year basis, we're also then bumping up against last year. We had a fairly large lottery project that we delivered on which was $50 million and so you have the combination of the write-off plus bumping up against a fairly tough compare from last year that is causing the variance really. When you look at it with regards to actions, we talked a little bit about this in the last quarter and we've had some further actions along those lines. I'm not going to give the exact number, but I will say we have reduced the overall head count in Brazil by a meaningful number and are continuing to take appropriate dealering (50

[Matt J. Summerville:]

And then with respect to – so you're in the midst of a divestiture. You obviously are in talks about a potential acquisition. Next year, in 2016, I believe is the last year of the turnaround grant, I believe, you've referred to it as, and you've talked about free cash flow being the metric for 2016. So how does all this M&A feed into how the Board is looking at that in terms of the yardstick, if you will, by which to judge senior management? And I guess what conversion rate should we be looking for given cash flow's a little disappointing this year relative to what you guys were thinking previously? Thank you.

[Christopher A. Chapman:]

Yeah. I would have a couple of comments on this, Matt, I think. Number one, if you look at our current cash flow and some of the items that have come through and impacting it, number one, we've talked about multi-vendor service and we've taken very specific actions there. In a longer-term view, as Andy talked about approximately net $40 million increase to the service business in North America next year, but we've also had to make an investment and we've had an increase in our service inventory of approximately $15 million to $20 million as well to be able to service all of these units that we've brought on. Again, that's looking long-term. Number two, with pressure on the cash flow this year, we've increased our restructuring by about $5 million and, again, that's taking this longer-term view of getting costs out and taking the appropriate actions now and not sitting back and just admiring these problems. And then additionally, we've had deal costs against some of these strategic things that we're doing. Unfortunately, the advisors and bankers don't give you free services here and so we have to appropriately incorporate this into our overall guidance as well. So, when you look at some of these items in the near term, it's all about the longer-term strategy in growth and trajectory of the company. And then, as we start to move forward and we get some of these items behind us, obviously, it's going to allow us to generate a much healthier overall conversion rate from a free cash flow standpoint. We've talked about being north of 100% on the NOPAT from a cash flow standpoint and again, we're going to continue to drive to that mark and ultimately exceed that mark, but again we have to take the right actions in the near term to drive the right long-term performance of the company.

[Andreas Walter Mattes:]

And that's exactly the way that the board thinks about how to evaluate management, which is are we doing the right thing for our company, for our customers, for our shareholders, for our employees going forward and do we give the company not just a 12-month, but do we give the company a 5- to 10-year runway to grow, which is also the philosophy when we said we're going to do mix adjustments in walk so we can kick into more growth in the run phase of our turnaround. So, a lot of heavy lifting, a lot of hard work all with the objective of making sure that Diebold has a great future and a great springboard for future growth and be able to take advantage of the shift in the market and the opportunities that are created with that.

[Matt J. Summerville:]

Very helpful. Thank you.

[Operator:]

Next, we'll go to Brendan Hardin with Northcoast Research.

[Kartik Mehta:]

Hey, Andy. Hey, Chris. This is Kartik. Hey, Andy, wanted to ask you about the servicing business and maybe if you could just talk about why you're winning these businesses. Has something changed on the marketplace? Is it how you're going to market? What's the catalyst that's allowing you to win?

[Andreas Walter Mattes:]

Kartik...

[Kartik Mehta:]

Yes.

[Andreas Walter Mattes:]

...the more advanced the machines get, the more processes you put on self-service. The more you drive branch transformation, it's becoming a services play. It's all about uptime, it's all about availability, it's all about ease of use, it's all about remote service capability, and ultimately, it's all about a service model. And as you know from your own research, we score in every one of those buckets ahead of any competitor out there. And I mean, I cannot give you the customer, but I can assure you that of the four deals we won this year, one of them already gave us testament that other people's machine run better under Diebold management than they've ever run before under the management of the original manufacturer. And that's why we're winning. It's dedication to customers and having the best service. We've said service is our core business going forward and we're being rewarded by our customers.

[Kartik Mehta:]

And then, Andy, you talked about restructuring China so that you can now go under the new rules that they have there. Will that change the economics? And if so, do you expect much of an impact?

[Andreas Walter Mattes:]

Yes, yes, and a yes. But it's too early to squawk. Just think about it this way, Kartik. The only way that you're going to do business in China is if you're being categorized as Chinese in the bucket. And I mean, let's be very clear, everything we're talking about is a hardware play because I think I said it on the call, our service business in China is actually growing very nicely. So, how do you come up with a hardware structure where we're more Chinese than we are today, where we're not having a multi-national company discount but where we have a local partnership premium? But you got to do this in a way that's compliant with SEPA. You got to do it in a way that you have a serious business partner that's predictable, that understands how U.S. companies tick and click, and there are many, many pitfalls if you don't do your homework. And that's exactly what we're doing right now. We're very encouraged with the progress and the options that we have on the radar screen, and we hope that we will be in a position on our next earnings call, we will be able to outline the China strategy going forward. But once again, we're not sitting back and admiring the problem. We want to make sure we take our own destiny in our own hands.

[Kartik Mehta:]

And last question for you, Chris. Fourth quarter, you're expecting a pretty big free cash flow number to kind of get to your guidance. How much visibility do you have to that number? And I guess maybe this might be difficult, but what percentage do you feel like you have visibility to and what percentage of the business has to come through in the fourth quarter so you can achieve your target?

[Christopher A. Chapman:]

First with regards to the number in the fourth quarter, if you look back the last four years, the fourth quarter expectation is basically in line with what we've done in those last several year-ends. And so it's pretty much typical from a seasonality that we deal with. With regards to visibility, obviously there are always some timing things that are outside of your control. I feel good about the focus of the organization. The time that we spend on it is significant. We goal our organization on the metrics around working capital and free cash flow and we obviously control certain aspects of that and we'll look to deliver on our commitments.

[Kartik Mehta:]

Thank you very much. I really appreciate it.

[Operator:]

Next, we'll go to Meghna Ladha with Susquehanna.

[Meghna Ladha:]

Hi. Thank you. Good morning. Most of my questions have been answered. Just a quick one, Andy. What do you think is the long-term growth outlook of the ATM industry globally and what gives you confidence it can grow at that rate?

[Andreas Walter Mattes:]

That's a great question, Meghna. The way you got to think about it is that BRIC, at least for the next three years, has pretty much been reduced to I, which means if you take a look at RBR reports and all of that, once you exclude BRIC growth, which the market research gurus had it round about 9% in units, you'll end actually up with a low-single digit unit growth scenario and which again revalidates our approach to more services because low-single digit units would actually translate into flat dollars if you subtract the 5% headwind on the pricing. So in order to remain in the single-digit growth rate outlook going forward, all of that has to come from services and from software.

[Meghna Ladha:]

Thanks, Andy.

[Andreas Walter Mattes:]

Now, here's some good news on the services side. Most market research companies do not have the services opportunity in their numbers. I want to say 80% of the spend that all the banks around the globe have every year to run, maintain their ATMs is currently in-house spend within the cost centers of the banks. It's not in any of the TAM numbers. Once you add that business and you turn that from an insourced model into an outsourced model, into a partnership model, in a managed services model, all of a sudden you're starting to add meaningful chunks of market opportunity to the TAM. In my mind, we're about to triple the TAM in our industry between now and then end of the decade.

[Meghna Ladha:]

Got it. Thank you.

[Operator:]

Next, we'll go to Justin Bergner with Gabelli & Company.

[Justin Laurence Bergner:]

Good morning, Andy. Good morning, Chris.

[Christopher A. Chapman:]

Hey, Justin.

[Andreas Walter Mattes:]

Morning.

[Justin Laurence Bergner:]

Just a couple clarification questions. The write-off or the bad debt in Brazil, what exactly is it affecting on the balance sheet?

[Christopher A. Chapman:]

So you would have a combination of an impact to inventory, and that's roughly, I think, two-thirds of the amount, and then you have the other impact, which would be impacting on finance receivables varied between – there would have been a short- and long-term component but in the finance receivables.

[Justin Laurence Bergner:]

Okay. Great. On the subject of receivables, how much of the $20 million reduction in free cash flow guidance is related to accounts receivable? I mean, inventory seems sort of in check but receivables seems a bit high again at the end of this quarter.

[Christopher A. Chapman:]

It's not. It's really the other items that I've talked about. Overall, expectations on receivables are in line with where we've ended historically in previous year-ends.

[Justin Laurence Bergner:]

Thank you.

[Andreas Walter Mattes:]

And then on receivables, let me reiterate. Chris was mentioning it in his prepared remarks. We've cleared a very, very big milestone for our company with our Oracle upgrade. It was mandatory for us to make sure that next year's service invoices, those are 12-month invoices, are being done on the new system because had we not passed that milestone, we would have had the accounts receivables for yet another year in the old technology. So we – very crucial milestone on our IT transformation side. Our IT team has done an incredible job around that. It did slip it out a little in the quarter, which is why we have the $20 million impact that Chris mentioned. People just couldn't pay the invoice soon enough, fast enough within the quarter, but that's why we did it in Q3 and not in Q4. So we got it on the new system. It's all out there in a way that customers can actually understand our services invoices, and have all the opportunity in the world to start paying as of this quarter.

[Justin Laurence Bergner:]

Okay. Great. So the receivables impact on the free cash flow guidance is negligible. I guess that's what I'm hearing. Question on the security divestiture. What is the after-tax estimated proceeds?

[Christopher A. Chapman:]

I'm not going to give an exact number on that at this time. Obviously, you've got to go through all of your final purchase accounting and your balance sheet adjustments, all those ins and outs which can ultimately impact the proceeds. Again, cash could already be in-house so to speak when you think about it from that perspective. I would say that we have generated some foreign tax credits that we'll have the ability to utilize. And so, the overall tax impact on this is not going to come out just at the blanket U.S. statutory rate, we'll have a little bit of an offset there. So, I would say the blended tax rate impact on this would probably be best to use to corporate average of around 20% and then we'll update further on that after we finalize all of that purchase accounting work in the January timeframe.

[Justin Laurence Bergner:]

Okay. Great. Thank you. But any sort of suggestions as to what that 20% rate would mean in terms of dollars?

[Christopher A. Chapman:]

I'll update you on that after the end of the fourth quarter when we finalize the transaction.

[Justin Laurence Bergner:]

Okay. That's fair. And then on the question of security margins, you mentioned that electronic security or the North America business I think was about 7.5% margin. And then you also mentioned the physical security is a strong margin-producing business for you. I mean, should we sort of conclude that, overall, security margins are sort of above the corporate average from your comment?

[Christopher A. Chapman:]

Yeah. I don't think it's fair just to apply it in that fashion. Again, I'm giving the stand-alone average on that. I'm not allocating back any of the global or corporate costs where you would have some of that allocation that's not sitting in one of the operating units. So I think net-net, when you look at the blended overall geographic businesses, most of our regions are running in double-digit margins, excluding for the allocation of the corporate and global overhead. So, net-net, it's probably under when you – if you were to fully burden it with all of the corporate and global overhead holistically.

[Justin Laurence Bergner:]

Okay. That's very helpful. So the 7.5% is more of a pre-corporate number.

[Christopher A. Chapman:]

Correct. That's how you should think about it whenever you think of discontinued ops moving forward, the pieces that we're going to be taking out and then, obviously, we will have some other cost actions that will take – tied to some of the stranded costs the company would have, but that's how you should think about it from a modeling standpoint.

[Justin Laurence Bergner:]

Okay. Fantastic. And finally, I just want to commend you guys on what looks like a strong quarter of share gains at least, excluding whatever headwinds you're facing in Asia-Pacific. Might you sort of comment on sort of the pace of share gains that you saw in EMEA and/or other regions in the quarter?

[Andreas Walter Mattes:]

It's all about dedication and end-to-end solutions and services-led approaches to the customers. Our next gen product line is hitting it out of the park. Our security features – I mean, you saw that. Just take Mexico, right, 2,200 machines with anti-skimming on it. And as I said early on the biometric question that was raised is when that becomes more of a reality in the market, security becomes a very attractive position. And then the fact that we are the drivers of our own destiny, we've got no questions about the longevity of our company. We're dedicated to our customers. We're driving innovation, very, very well-received and you can see it. We've made investments in Europe last year. We've made investments into Africa. We're gaining in Africa. We've made investments into the Middle East. We're gaining share in the Middle East, which is why we're also opening the office in Dubai Even the win in Romania is an investment that we made in the sales force last year and they're all competitive wins. And they all come from our established competitors out there in the market, and we're shaping new opportunities together with our customers. So, we're very excited. Our pipeline is full of creative ideas. Take a look at what we're doing with Citi. That's true leading-edge technology in collaboration with a customer that will drive a lot of positive momentum going forward. So, we know we're taking share and we're getting all the feedback from the customers that we're doing the right things, we're not confused, and that they like to entrust their business with us.

[Justin Laurence Bergner:]

Great. Thanks. Keep up the good work.

[Andreas Walter Mattes:]

Thank you.

[Stephen A. Virostek:]

Good. Operator, I believe that's the last question for today. I want to thank everyone for joining us. If you have any calls, please dial us up at Investor Relations. Thank you.

[Operator:]

And that concludes today's conference. Thank you for your participation.