Business Context and Reporting Period
Diebold, Incorporated (the filing predates the Diebold Nixdorf name) filed this unaudited Form 10-Q for the quarter ended March 31, 2014. The company provided financial self-service, security, services, software and, primarily in Brazil, information-technology solutions in more than 90 countries with approximately 16,000 employees.
Management was executing the multi-year “Diebold 2.0” turnaround strategy, focused on cost reduction, cash generation, talent, services and software, and profitable growth.
Financial Performance and Position
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $688.3 million | $633.5 million | 8.6% increase |
| Gross profit | $164.1 million | $130.0 million | 26.2% increase |
| Gross margin | 23.8% | 20.5% | Up 3.3 percentage points |
| Operating profit (loss) | $23.3 million | $(13.9) million | Improved $37.2 million |
| Operating margin | 3.4% | (2.2)% | Up 5.6 percentage points |
| Net income (loss) | $4.9 million | $(13.9) million | Improved $18.8 million |
| Net income (loss) attributable to Diebold | $9.8 million | $(13.4) million | EPS improved to $0.15 from $(0.21) |
| Cash flow from operating activities | $(31.6) million | $(31.7) million | Essentially unchanged |
- Services revenue was $383.4 million, essentially flat year over year; product revenue increased 21.3% to $304.9 million.
- Service gross margin improved to 28.2% from 22.3%, primarily from lower employee-related costs associated with restructuring, the pension freeze and voluntary early retirement program.
- Net income included $11.6 million of net other expense, including a $12.0 million foreign-exchange loss. The effective tax rate was 58.3%, compared with 18.4% in the prior-year quarter.
- At March 31, 2014, cash and cash equivalents were $217.2 million, short-term investments were $209.0 million and total global liquidity was $743.4 million, including available credit facilities.
- Total debt was $536.0 million, consisting of $79.0 million of notes payable and $457.1 million of long-term debt. The company was in compliance with its debt covenants.
- Total assets were $2.33 billion and shareholders’ equity attributable to Diebold was $610.3 million.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven principally by $69.5 million of additional Brazil “other” revenue from information-technology equipment deliveries to the education ministry. Financial self-service revenue declined 4.1%, while security revenue increased 3.7%.
- North America revenue declined 4.0%, but segment operating profit increased 26.4% to $58.2 million. EMEA revenue increased 27.3% and segment operating profit increased 164.1% to $11.3 million.
- Brazil revenue increased 65.9% to $130.6 million and shifted from a $1.2 million operating loss to $10.0 million of operating profit, largely due to the education-related IT deliveries and favorable mix.
- Restructuring charges declined to $5.1 million from $9.5 million. Net non-routine expenses declined to $1.1 million from $8.2 million, with the prior-year period including executive severance and accelerated share-based compensation.
- Cash flow remained negative because of working-capital investment, including increases in trade receivables, inventories and finance lease receivables. Finance lease receivables increased to $130.6 million from $74.5 million at year-end 2013.
- Cash declined by $13.5 million during the quarter, including an $11.2 million negative effect from exchange-rate changes.
Guidance, Outlook, Commentary and Risks
- Management targeted $150.0 million of cumulative savings from the multi-year realignment plan, expected to be fully realized by the end of 2015, with approximately 50% expected to benefit operating profit. Additional restructuring costs of $9 million to $12 million were expected through the end of 2014.
- The company expected services and software to exceed 60% of sales during the transformation and planned investments in research and development, information technology, sales coverage and back-office capabilities.
- Management stated that available capital resources were expected to fund working capital, research and development, facilities and equipment, pension contributions, dividends and potential share repurchases for at least the next 12 months.
- Venezuela was remeasured using the SICAD 2 exchange rate of 50.86 versus 6.3 previously. This caused a $12.1 million loss, a $6.1 million reduction in cash and a $4.1 million service-inventory write-down. Further gains or losses were possible if bolivars were converted at another rate.
- The company had a Brazilian indirect-tax assessment of approximately R$270.0 million. The matter was pending, and management estimated aggregate reasonably possible exposure for material indirect-tax matters of up to approximately $395.0 million, against an accrual of approximately $26.0 million.
- Disclosure controls and procedures were deemed ineffective as of March 31, 2014 because of material weaknesses involving Brazilian indirect-tax controls and communication, and adoption of an enterprise-resource-planning system and account reconciliations in India. Remediation was expected to continue through 2014, but there was no assurance it would be successful.
- Other risks included foreign-exchange volatility, customer capital-spending cycles, competitive and pricing pressure, technology acceptance, cybersecurity, pension funding, tax and regulatory changes, access to credit and execution of the turnaround and outsourcing initiatives.
Important Facts for Investors to Verify
- Whether the revenue and profit improvement is sustainable after the Brazil education-ministry deliveries and other favorable mix effects.
- Progress toward the $150.0 million realignment savings target, the remaining restructuring charges and the portion translating into operating profit and cash flow.
- Working-capital requirements, particularly finance lease receivables in Brazil, receivables collection and inventory levels.
- The outcome and potential financial impact of the Brazilian indirect-tax assessment and related SEC document request.
- Remediation and eventual effectiveness of the identified internal-control material weaknesses in Brazil and India.
- Further Venezuelan currency exposure and the effect of foreign-exchange movements on cash, earnings and reported revenue.
- Debt maturities, variable-rate exposure, covenant compliance and the company’s ability to maintain dividends while operating cash flow remains negative.