Business Context and Reporting Period
Diebold, Incorporated filed this unaudited Form 10-Q for the quarter and six months ended June 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 50% of revenue.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2011 | Three Months Ended June 30, 2010 | Six Months Ended June 30, 2011 | Six Months Ended June 30, 2010 |
|---|---|---|---|---|
| Net sales | $662.4 million | $665.2 million | $1,276.5 million | $1,284.2 million |
| Gross profit | $169.5 million | $178.1 million | $318.9 million | $336.2 million |
| Gross margin | 25.6% | 26.8% | 25.0% | 26.2% |
| Operating profit | $25.1 million | $46.9 million | $34.0 million | $87.4 million |
| Operating margin | 3.8% | 7.0% | 2.7% | 6.8% |
| Income from continuing operations | $21.6 million | $31.1 million | $25.7 million | $56.3 million |
| Net income attributable to Diebold | $20.8 million | $29.7 million | $23.3 million | $53.7 million |
| Diluted EPS | $0.32 | $0.45 | $0.35 | $0.80 |
Six-month operating cash flow was negative $100.0 million, compared with negative $17.5 million in the prior-year period. Investing activities provided $12.8 million, while financing activities provided $31.1 million. Cash and cash equivalents declined to $278.7 million from $328.7 million at December 31, 2010.
At June 30, 2011, short-term investments were $261.2 million, total current assets were $1.79 billion and total assets were $2.60 billion. Current liabilities were $808.4 million. Debt comprised $43.9 million of current notes payable and $644.7 million of long-term debt; total debt instruments had carrying value of $688.6 million and fair value of $704.4 million.
The new five-year credit facility had a $500.0 million borrowing limit, with $170.0 million available at quarter-end. International short-term lines had $49.7 million available. The company was in compliance with its financial covenants.
Material Changes Versus the Prior Comparable Period
- Second-quarter revenue declined 0.4%, while six-month revenue declined 0.6%.
- Gross margin declined 1.2 percentage points in both the quarter and year-to-date period, reflecting lower product and service margins, unfavorable customer mix in EMEA, higher service costs and restructuring charges.
- Second-quarter operating profit fell 46.4% to $25.1 million; six-month operating profit fell 61.1% to $34.0 million.
- Second-quarter income from continuing operations attributable to Diebold declined 33.4% to $20.3 million; six-month income declined 58.8% to $22.8 million.
- DNA revenue increased 4.8% in the quarter and 4.1% year to date, with DNA operating profit increasing 4.0% and 27.6%, respectively.
- DI revenue declined 5.3% in the quarter and 4.9% year to date. DI operating profit fell to $0.6 million in the quarter and a $7.9 million loss year to date, primarily because of lower Brazilian election-system volumes, lower product margins and higher restructuring and non-routine costs.
- Financial self-service revenue increased, but election and lottery revenue declined 91.5% in the quarter and 76.1% year to date because of cyclical Brazilian election purchasing.
- Selling and administrative expense increased 10.2% in the quarter and 15.9% year to date. Research, development and engineering expense increased 18.1% and 11.3%, respectively.
- Operating cash flow deteriorated primarily because of lower earnings, unfavorable changes in refundable income taxes and higher pension contributions.
Guidance, Outlook, Risks and Unusual Items
Management expects capital resources to be sufficient for planned working capital, research and development, capital investment, pension contributions, dividends and share repurchases for at least the next 12 months. No specific revenue or earnings guidance was provided.
Management is pursuing a more services-oriented strategy, expansion of integrated services and security offerings, and continued investment in software and emerging markets. The company signed more than $75 million of integrated services contracts in the second quarter. Its SmartBusiness 300 program targets $100 million of efficiencies over three years, with $30 million of cost reductions targeted for 2011. Management continues to target a 15% return on capital employed.
- Restructuring charges were $16.3 million for the first six months, primarily related to the EMEA reorganization. Additional EMEA restructuring costs of $10 million to $13 million were expected through 2012.
- Net non-routine expense was $13.4 million year to date, primarily legal and compliance costs related to the FCPA investigation, compared with net non-routine income of $3.1 million in the prior-year period.
- The company self-reported potential FCPA issues in Russia and Asia Pacific to the SEC and DOJ. The SEC inquiry became a formal non-public investigation, and the company received an SEC subpoena and DOJ document request. The internal review was expected to conclude by the end of 2011, but the potential loss and financial impact could not be estimated and could be material.
- Guarantees and standby letters of credit had maximum future payment obligations of $77.7 million, with no associated liability recorded.
- Routine legal proceedings were not considered material by management. Certain securities, derivative, labor, election-related and other proceedings remained outstanding; the financial impact of the securities class action and shareholder derivative lawsuit could not be determined.
- The company repurchased 1.1 million shares during the quarter for $36.1 million and had 2.4 million shares remaining under its repurchase authorization at June 30, 2011.
- Foreign currency movements, customer capital spending, Brazilian election cycles, competitive and technology pressures, pension performance, restructuring execution, credit availability and the FCPA investigation were identified as material risks.
Facts Investors Should Verify
- Progress, total cost and savings realization of the EMEA restructuring and SmartBusiness 300 initiatives.
- Cash conversion and working-capital requirements given the $100.0 million year-to-date operating cash outflow.
- Debt levels, variable-rate exposure, credit-facility availability and compliance with financial covenants.
- Revenue and margin sustainability in DNA versus continued weakness in DI, especially Brazil election-system demand.
- Outcome and potential financial exposure from the SEC and DOJ FCPA investigations and related litigation.
- Whether services growth and integrated-services contracts offset pressure in product margins and traditional security markets.
- The filing contains an apparent inconsistency in one MD&A six-month gross-profit table, which labels the comparative year as 2009 even though the financial statements and surrounding discussion compare 2011 with 2010.