DIEBOLD NIXDORF, Inc quarterly report, Q3 FY2014

Diebold, Incorporated — Q3 2014 Form 10-Q Summary

Business context and reporting period

Diebold, Incorporated is a global provider of financial self-service, security, software, integrated services and information technology solutions, operating in more than 90 countries with approximately 16,000 employees. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.

Management’s “Diebold 2.0” turnaround strategy focuses on cost reduction, cash generation, talent, services and software growth, and a return to sustainable profitable growth.

Key financial metrics

Metric	Q3 2014	Q3 2013	9M 2014	9M 2013
Revenue	$768.0 million	$705.4 million	$2.190 billion	$2.046 billion
Gross profit	$200.6 million	$172.8 million	$551.5 million	$460.2 million
Gross margin	26.1%	24.5%	25.2%	22.5%
Operating profit (loss)	$46.7 million	$(30.3) million	$127.2 million	$(67.8) million
Operating margin	6.1%	(4.3)%	5.8%	(3.3)%
Net income attributable to Diebold	$33.0 million	$(21.7) million	$84.5 million	$(140.2) million
Diluted EPS	$0.51	$(0.34)	$1.30	$(2.20)

Revenue increased 8.9% in the quarter and 7.0% year to date. Nine-month growth was driven substantially by Brazil other revenue, including education ministry IT deliveries that management does not expect to recur in 2015.
Service gross margin improved to 30.3% in Q3 and 29.8% year to date, versus 28.4% and 24.7%, respectively, in 2013. Product gross margin was 21.2% in Q3 and 19.5% year to date.
Segment operating profit increased to $123.9 million in Q3 and $336.7 million year to date. All segments except Latin America improved year-to-date operating profit, with the strongest growth in EMEA and Brazil.
Nine-month operating results benefited from substantially lower restructuring and non-routine charges and the absence of the $70.0 million Brazil goodwill impairment recorded in Q3 2013.

Cash flow, liquidity and debt

Net cash used in operating activities was $110.7 million for the first nine months of 2014, compared with $59.0 million used in 2013. Working capital absorbed cash, including increases of $164.7 million in trade receivables and $156.3 million in inventories.
Investing activities provided $65.0 million, primarily reflecting investment maturities and sales, partly offset by $33.6 million of capital expenditures and $11.7 million for the Cryptera acquisition.
Financing activities provided $69.4 million, including net revolving debt borrowings and other debt activity. Dividends paid were $56.2 million, or $0.2875 per share quarterly.
Cash and cash equivalents were $240.4 million at September 30, 2014, compared with $230.7 million at December 31, 2013. Global liquidity, including short-term investments and available credit, was $620.6 million, down from $798.4 million at year-end.
Total debt was $638.6 million at September 30, 2014, compared with $524.0 million at December 31, 2013. Long-term debt was $555.0 million, including $315.0 million under the credit facility and $225.0 million of senior notes.
The amended credit facility increased total commitments from $500.0 million to $520.0 million, expires in August 2019, and had $205.0 million available at quarter-end. The company reported compliance with its debt covenants.
Approximately 99.1% of cash and short-term investments were held in international tax jurisdictions. Management stated that available capital resources should fund expected needs for at least the next 12 months, although repatriation could create additional tax costs.

Material changes versus the prior comparable period

Profitability recovered sharply from the 2013 losses, reflecting improved service margins, higher product sales, lower non-routine expenses and the absence of the prior-year goodwill impairment.
Q3 revenue growth was led by AP, EMEA and Brazil, while nine-month North America revenue declined 3.0% because of lower U.S. national-bank product volume and a large non-recurring 2013 project.
Financial self-service revenue was essentially flat for the first nine months, while security revenue increased 2.8%. Brazil other revenue increased 264.4% year to date.
Restructuring charges declined to $6.8 million year to date from $21.4 million. Selling and administrative expense declined 5.9% year to date, but increased 16.3% in Q3 as savings were reinvested in transformation initiatives.
The company acquired Cryptera for approximately $13.0 million and divested Diebold Eras for $20.0 million, recording a $13.7 million pretax gain on the sale.
Venezuela was remeasured using the SICAD 2 exchange rate, producing a $12.1 million foreign-exchange loss and a $4.1 million service-inventory adjustment during the first quarter. Venezuela represented less than 1% of consolidated assets and revenue.

Guidance, outlook, commentary and risks

The multi-year realignment plan targets $150.0 million of savings fully realized by the end of 2015; management expects approximately 50% of the savings to benefit operating profit. Additional 2014 restructuring costs of $4.0 million to $6.0 million were expected, with further costs through at least 2015.
Management expects services and software to exceed 60% of sales during the transformation and intends to reinvest savings in research and development, information technology, back-office transformation, sales coverage and marketing.
Key business drivers include ATM replacement cycles, branch transformation, outsourcing and managed services, security demand, and emerging-market deployments. The company cautioned that Brazil education ministry IT deliveries are not expected to recur in 2015.
Principal risks include foreign-exchange volatility, Brazil and Venezuela economic and regulatory conditions, pricing and competitive pressure, customer capital spending, technology acceptance, cybersecurity, pension funding, execution of restructuring and business-process outsourcing, and the ability to sustain working-capital improvements.
A material weakness existed in internal control over financial reporting as of September 30, 2014, involving account reconciliations in the Indian subsidiary following implementation of a new enterprise resource planning system. Management expected remediation by year-end 2014 but stated that additional efforts might be necessary. The previously reported Brazil indirect-tax and communication weakness was considered remediated.
The company maintained a $26.0 million accrual related to a Brazilian indirect-tax matter and estimated aggregate reasonably possible excess exposure of up to approximately $395.0 million for material indirect-tax matters. A Thailand customs dispute could result in a retroactive assessment; no amount was accrued.
The IRS proposed a $6.3 million net tax deficiency, excluding interest, for 2008–2010 tax years. The company protested the assessment and believes it has adequately provided for uncertain tax positions.

Investor verification items

Verify whether operating cash flow improves from the first-nine-month outflow and whether receivables, inventories and Brazil finance leases normalize.
Assess the sustainability of service-margin gains and the extent to which restructuring savings translate into operating profit rather than reinvestment or higher costs.
Track debt growth, interest-rate exposure, covenant headroom and the timing of senior-note and industrial-revenue-bond maturities.
Monitor the nonrecurrence of Brazil education ministry deliveries and the performance of the Brazil and Venezuela operations under currency and regulatory pressure.
Follow remediation of the India internal-control material weakness and any effects on reported results.
Review developments in the Brazilian indirect-tax and Thailand customs contingencies, including any exposure above recorded accruals.
Consider the quality of year-to-date earnings, which benefited from the $13.7 million Eras divestiture gain and the absence of significant 2013 impairment, FCPA, securities-settlement and severance charges.