Diebold, Incorporated (Diebold Nixdorf) — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; filed November 14, 2016. The filing covers Diebold, Incorporated and subsidiaries. The Wincor Nixdorf acquisition closed August 15, 2016, substantially expanding the company’s international operations, retail exposure and employee base.
Business context
The company provides financial self-service, retail, security, software and services solutions. Following the acquisition, operations span more than 130 countries with approximately 25,000 employees. Management is pursuing a services-led and software-enabled strategy and expects approximately $160 million of annual synergies by 2019, with estimated integration costs of approximately $130 million to $160 million through 2019.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $983.3 million | $589.6 million | $2,072.9 million | $1,808.9 million |
| Gross profit | $197.6 million | $150.3 million | $491.5 million | $480.3 million |
| Gross margin | 20.1% | 25.5% | 23.7% | 26.6% |
| Operating profit (loss) | $(86.7) million | $12.4 million | $(82.1) million | $33.4 million |
| Operating margin | (8.8)% | 2.1% | (4.0)% | 1.8% |
| Net income (loss) attributable to Diebold | $(102.3) million | $21.7 million | $44.8 million | $41.1 million |
| Diluted EPS | $(1.44) | $0.33 | $0.66 | $0.63 |
| Cash flow from operating activities | Not separately provided for the quarter | Not separately provided for the quarter | $(194.9) million | $(120.1) million |
Continuing operations produced a net loss of $97.2 million in Q3 and $97.3 million for the first nine months, compared with income of $18.2 million and $27.8 million, respectively, in the prior-year periods. Nine-month net income was supported by $143.7 million of discontinued operations income, principally the $145.0 million after-tax gain from the sale of the North American electronic security business.
Revenue and segment performance
- Q3 revenue increased 66.8% and nine-month revenue increased 14.6%, primarily because of the Wincor Nixdorf acquisition.
- Financial self-service revenue increased 36.7% in Q3 and 4.1% for the first nine months. Retail revenue contributed $173.6 million in both reported periods as a result of the acquisition.
- Security revenue declined 11.4% in Q3 and 9.4% year to date. Brazil other revenue increased because of election equipment sales.
- Q3 segment revenue and operating profit were: North America $305.4 million and $50.1 million; Asia Pacific $138.5 million and $16.1 million; EMEA $371.3 million and $36.9 million; and Latin America $168.1 million and $12.8 million.
- Product gross margin fell to 9.9% in Q3 and 12.9% year to date, substantially affected by purchase-accounting inventory valuation adjustments related to Wincor Nixdorf. Service gross margin was 28.4% in Q3 and 31.0% year to date.
Cash flow, liquidity and debt
- Cash and cash equivalents were $748.2 million at September 30, 2016, compared with $313.6 million at December 31, 2015. Total reported cash availability, including short-term investments and undrawn credit facilities, was $1,446.3 million.
- Operating activities used $194.9 million in the first nine months, including $186.7 million from continuing operations and $8.2 million from discontinued operations.
- Investing activities used $517.1 million, including $890.6 million for the Wincor Nixdorf acquisition, partially offset by $361.9 million of proceeds from the electronic security divestiture.
- Financing activities provided $1,138.7 million, primarily from acquisition-related borrowings. Capital expenditures were $23.9 million.
- Notes payable were $336.4 million and long-term debt was $1,722.5 million at September 30, 2016, compared with $32.0 million and $606.2 million, respectively, at year-end 2015. Debt included $400.0 million of 8.5% senior notes due 2024, U.S. and euro Term Loan B facilities, and a $205.6 million Term Loan A balance.
- The company had $520.0 million available under its revolving credit facility and $138.2 million available under international uncommitted lines. It was in compliance with its debt covenants at September 30, 2016, including a maximum net leverage ratio of 4.50 and minimum adjusted EBITDA-to-net-interest coverage ratio of 3.00.
- The company paid $57.0 million of dividends during the first nine months, or $0.8625 per share. A fourth-quarter 2016 dividend of $0.10 per share was announced.
Material changes versus the prior comparable period
- Wincor Nixdorf was acquired for preliminary consideration of $1.2657 billion, including $995.3 million cash paid and $279.7 million of Diebold shares. The acquisition contributed $405.3 million of revenue and a $41.6 million net loss attributable to Diebold from August 15 through September 30, including purchase-accounting charges.
- Total assets increased to $5.7813 billion from $2.2424 billion at December 31, 2015. Goodwill increased to $991.0 million and intangible assets to $869.7 million, primarily from the acquisition.
- Gross margin declined 540 basis points in Q3 and 290 basis points year to date. Operating results shifted from profit to loss, reflecting acquisition and integration costs, acquired inventory and deferred-revenue adjustments, higher amortization, and higher corporate and financing costs.
- Interest expense increased to $32.4 million in Q3 and $68.2 million year to date from $8.5 million and $24.1 million, respectively, because of acquisition financing.
- Non-routine expense was $127.2 million in Q3 and $159.5 million year to date, including acquisition, divestiture and integration-related costs. Restructuring expense was $7.4 million in Q3 and $12.8 million year to date.
- The North American electronic security business was sold on February 1, 2016 and is reported as discontinued operations. The company also received proceeds and receivables related to divestitures of certain Chinese businesses.
Guidance, outlook, risks and unusual items
- Management expects approximately $160 million of annual acquisition synergies by 2019 and integration costs of approximately $130 million to $160 million through 2019. The filing does not provide a clear consolidated revenue or earnings forecast.
- The proposed Domination and Profit and Loss Transfer Agreement with Wincor Nixdorf remained subject to registration and shareholder litigation in Germany. If effective, Diebold KGaA would generally absorb Wincor Nixdorf losses and guarantee payments to minority shareholders, including potential cash compensation of €55.02 per share or recurring compensation of €3.13 per share annually.
- The Wincor Nixdorf combination remained subject to review by the United Kingdom Competition and Markets Authority. The company was required to operate the businesses separately in the U.K. pending clearance and could face remedies, divestitures, costs or integration delays.
- Material risks include acquisition integration, realization of synergies, elevated leverage and interest costs, foreign exchange volatility, Brexit-related economic and regulatory uncertainty, competitive and technology pressures, customer capital spending, information-security risks, pension funding, litigation and tax contingencies.
- Material indirect-tax matters included a Brazil assessment and Thailand customs disputes. Aggregate reasonably possible exposure for material indirect-tax matters was estimated at up to approximately $225.2 million, including $176.0 million related to Brazil and $25.0 million related to Thailand; the Brazil accrual was $9.2 million.
- Guarantees and standby letters of credit had maximum future payment obligations of $186.7 million, with no associated liability recorded. Purchase commitments due within one year were $22.6 million.
- The corporate monitorship related to prior FCPA settlements expired October 29, 2016 after the monitor certified that the compliance program was reasonably designed and implemented.
- Management concluded that disclosure controls and procedures were effective at September 30, 2016. The evaluation did not include Wincor Nixdorf’s internal controls, as permitted by SEC guidance, although oversight and monitoring were being extended to the acquired operations.
Investor verification points
- Verify the final purchase-price allocation, goodwill allocation, acquired intangible valuations and the extent of purchase-accounting charges.
- Track acquisition integration costs, synergy realization and the effect of acquired operations on service and product margins.
- Monitor leverage, covenant compliance, refinancing requirements, variable-rate exposure and subsequent debt repayment, including the $200.0 million Term Loan B repayment disclosed as occurring in November 2016.
- Assess operating cash-flow conversion and working-capital requirements, particularly receivables, inventories and deferred revenue.
- Follow the German DPLTA litigation and registration process and the U.K. CMA review, including any required remedies or restrictions.
- Evaluate the potential impact of Brazil and Thailand tax contingencies, guarantees, pension obligations and other legal claims.
- Reconcile reported net income with continuing operations and the non-recurring gain from the discontinued electronic security business.
- Confirm the company’s planned transition to Software, Systems and Services reporting segments beginning in the first quarter of 2017.