Business Context and Reporting Period
Diebold, Incorporated filed an unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. The company sells and services financial self-service, security, election and lottery systems through Diebold North America (DNA) and Diebold International (DI). Services represented more than half of revenue, consistent with management’s strategy to become a more software-led services company.
Key Financial Metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $709.3 million | $748.6 million | $1,985.9 million | $2,032.8 million |
| Gross profit | $194.4 million | $193.9 million | $513.3 million | $530.0 million |
| Gross margin | 27.4% | 25.9% | 25.8% | 26.1% |
| Operating profit | $54.4 million | $52.4 million | $88.4 million | $139.8 million |
| Operating margin | 7.7% | 7.0% | 4.5% | 6.9% |
| Income from continuing operations attributable to Diebold | $41.8 million | $44.1 million | $64.5 million | $99.4 million |
| Diluted EPS from continuing operations | $0.65 | $0.66 | $0.99 | $1.49 |
| Net income attributable to Diebold | $41.8 million | $46.1 million | $65.1 million | $99.8 million |
For the nine months, operating cash flow was negative $54.7 million versus positive $51.1 million in the prior-year period. Investing cash flow was positive $4.3 million, while financing cash flow was negative $23.6 million. Capital expenditures were $38.5 million, dividends paid were $55.1 million, and share repurchases were $104.9 million.
At September 30, 2011, cash and cash equivalents were $256.8 million, short-term investments were $215.4 million, and total debt was $703.6 million, including current notes payable of $37.3 million and long-term debt of $666.3 million. The new five-year credit facility had $148.0 million of availability under a $500.0 million borrowing limit; international short-term credit lines had $63.3 million available. Management stated that liquidity should be sufficient for at least the next 12 months, although approximately 98% of cash and short-term investments were held in international tax jurisdictions.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue declined 5.2%, while nine-month revenue declined 2.3%. The primary drivers were lower Brazil financial self-service and election revenue and weaker security revenue.
- DNA performed strongly: third-quarter revenue increased 4.1% and operating profit increased 27.6%; nine-month revenue increased 4.1% and operating profit increased 27.6%.
- DI weakened materially: third-quarter revenue decreased 13.5% and operating profit decreased 41.0%; nine-month revenue decreased 8.1% and operating profit decreased 96.2%.
- Third-quarter gross margin improved by 1.5 percentage points, led by service margin improvement and operating efficiencies. Nine-month gross margin decreased by 0.3 percentage points.
- Nine-month operating expenses increased 8.9%, including higher restructuring, non-routine, benefit and compliance costs. Operating profit fell 36.8% for the nine-month period.
- Nine-month restructuring charges increased to $17.7 million from $2.8 million, primarily due to the EMEA reorganization. The company expects an additional $10 million to $13 million of EMEA restructuring costs through 2012.
- Common-share repurchases increased substantially; approximately 1.7 million shares were repurchased in the third quarter for $47.3 million, and 669,977 shares remained authorized for repurchase at September 30.
- Total assets declined to $2.465 billion from $2.520 billion at December 31, 2010, while long-term debt increased by $115.9 million and shareholders’ equity declined by $130.4 million, partly reflecting repurchases and foreign-currency translation losses.
Guidance, Outlook, Risks and Unusual Items
- Management targeted $30 million of cost-structure reductions in 2011 and stated that its three-year SmartBusiness 300 program was intended to deliver an additional $100 million of efficiencies. The company continued to target a 15% return on capital employed.
- Management cited strong North American demand for financial self-service products, deposit automation and integrated services, along with growth opportunities in Asia Pacific and enterprise security services.
- Key operating risks include cyclical Brazil election and lottery demand, foreign-exchange volatility, customer capital-spending conditions, competition and pricing pressure, technology acceptance, and execution of EMEA restructuring and cost-reduction programs.
- The company’s internal review of potential Foreign Corrupt Practices Act matters in Russia and Asia Pacific remained ongoing. The company self-reported to the SEC and DOJ, received an SEC subpoena and a DOJ document request, and stated that the SEC inquiry had become a formal non-public investigation. Management could not estimate any potential loss; resolution could materially affect the financial statements.
- Routine legal proceedings were considered immaterial by management, but securities class-action and derivative litigation remained outstanding with unestimable potential losses. A labor settlement remained subject to court approval; Ohio election-related claims were settled and dismissed.
- The quarter included $2.6 million of non-routine expense, primarily FCPA-related legal and compliance costs. The nine-month period included $13.1 million of net non-routine expense versus $0.5 million of net non-routine income in the prior-year period.
- Third-quarter 2010 results included an immaterial out-of-period revenue adjustment reducing revenue by $18.7 million and operating profit by $5.3 million. The prior-year quarter also included $2.0 million of discontinued-operations income, including a tax benefit, that did not recur in 2011.
- Foreign currency translation produced a $57.4 million nine-month loss in accumulated other comprehensive income attributable to Diebold shareholders, contributing to lower equity.
Important Facts for Investors to Verify
- Whether negative operating cash flow and elevated inventories, which reached $512.4 million, reverse in the fourth quarter.
- The timing and ultimate cost of the EMEA restructuring, including the estimated additional $10 million to $13 million.
- The outcome, potential penalties and accounting impact of the SEC and DOJ FCPA investigations.
- Whether Brazil election-cycle weakness is temporary and how quickly DI margins recover.
- The company’s ability to fund dividends, repurchases, pensions and investment while operating cash flow remains negative and debt is elevated.
- The availability and covenant headroom under the new credit facility and the maturities of $75 million of senior notes in 2013, $175 million in 2016 and $50 million in 2018.
- The tax cost and practical availability of international cash and short-term investments if funds are repatriated.