DIEBOLD NIXDORF, Inc quarterly report, Q2 FY2014

Business Context and Reporting Period

Diebold, Incorporated filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2014. The company provides financial self-service, security, software, services and related solutions globally, with approximately 16,000 employees in more than 90 countries. Its reporting segments are North America, Asia Pacific, Europe, Middle East and Africa, Latin America, and Brazil.

Management is executing the multi-year “Diebold 2.0” turnaround strategy, focused on cost reduction, cash generation, talent, services and software, and sustainable profitable growth.

Financial Highlights

Unless otherwise stated, amounts are in thousands of dollars, except per-share data.

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Revenue	$733,457	$707,113	$1,421,750	$1,340,624
Gross profit	$186,795	$157,416	$350,928	$287,430
Gross margin	25.5%	22.3%	24.7%	21.4%
Operating profit (loss)	$57,202	$(23,622)	$80,481	$(37,538)
Operating margin	7.8%	(3.3%)	5.7%	(2.8%)
Net income (loss)	$43,131	$(103,852)	$48,007	$(117,734)
Net income (loss) attributable to Diebold	$41,635	$(105,035)	$51,441	$(118,481)
Diluted EPS	$0.64	$(1.65)	$0.79	$(1.87)

Revenue increased 3.7% in the second quarter and 6.1% year to date. Brazil other revenue, including lottery and information technology activity, was a major contributor.
Services revenue declined modestly in the quarter, while product revenue increased. Service gross margin improved to 30.8% from 23.3%; product gross margin declined to 18.7% from 20.9%.
Operating results benefited from improved service margins, lower restructuring and non-routine costs, and higher product sales.
Net income was affected by a 29.5% second-quarter effective tax rate and a 34.1% year-to-date effective tax rate. The second-quarter rate benefited from a $2,439 valuation allowance release related to the Eras sale.

Cash Flow, Balance Sheet, Debt and Liquidity

Cash flow from operations was an outflow of $91,775 for the first six months of 2014, compared with an outflow of $63,425 in the prior-year period. Working-capital uses included increases in receivables, inventories and finance lease receivables.
Investing activities provided $92,259, principally reflecting investment maturities and sales, compared with an investing outflow of $17,438 in the prior-year period.
Financing activities provided $2,786. Dividends paid were $37,404, and capital expenditures were $18,350.
Cash and cash equivalents were $222,863 at June 30, 2014, versus $230,709 at December 31, 2013. Short-term investments were $152,970, down from $242,988.
Total global liquidity was $687,107, consisting of cash, short-term investments, $62,314 available under international uncommitted lines, and $248,960 available under the five-year credit facility.
Debt totaled $553,537 at carrying value, including $63,105 of notes payable and $490,432 of long-term debt, compared with $524,033 at December 31, 2013. The company was in compliance with its debt covenants.
Total assets were $2,414,908 and total equity was $668,743 at June 30, 2014.
Management stated that available capital resources should be sufficient for at least the next 12 months. However, $365,676, or 97.3% of cash and cash equivalents plus short-term investments, was held in international tax jurisdictions.

Material Changes Versus the Prior Comparable Period

North America revenue declined 6.1% in the quarter and 5.1% year to date, but segment operating profit increased 16.1% and 20.5%, respectively, due primarily to service-margin improvements.
EMEA revenue increased 40.0% in the quarter and 34.4% year to date, while segment operating profit increased 132.6% and 142.4%.
Brazil revenue increased 37.7% in the quarter and 51.9% year to date, with the segment returning to operating profitability.
Latin America revenue and operating profit declined, primarily because of Venezuela and Colombia.
Financial self-service revenue declined 0.4% in the quarter and 2.1% year to date, while security revenue increased 2.3% and 3.0%, respectively.
Restructuring charges declined to $696 in the quarter and $5,833 year to date, versus $7,555 and $17,058 in the comparable 2013 periods.
The prior-year periods included substantial non-routine charges, including $28,000 related to the global Foreign Corrupt Practices Act investigation, $17,500 related to a securities litigation settlement, and executive severance costs.
The company sold its Eras subsidiary in the second quarter for $20,000, recognizing a $13,709 pretax gain. Eras contributed $6,011 of revenue and $2,970 of operating profit in the first six months of 2014.
On July 1, 2014, the company acquired Cryptera A/S for approximately $13,000 to strengthen its secure payment technology and PIN-pad capabilities.

Guidance, Outlook, Commentary and Risks

Management targets $150,000 of cumulative savings from the multi-year realignment plan, expected to be fully realized by the end of 2015. Approximately 50% of the savings is expected to benefit operating profit, with the remainder reinvested in growth and transformation initiatives.
Additional restructuring costs of approximately $7,500 to $10,000 were expected through the end of 2014, primarily in North America and EMEA.
Research and development and engineering spending was expected to increase during the second half of 2014. Accenture-related business-process-outsourcing reinvestment was also expected to increase.
Management expects services and software to exceed 60% of sales during the transformation, although the filing does not provide formal full-year revenue or earnings guidance.
Venezuela was remeasured using the SICAD 2 exchange rate, resulting in a $12,101 foreign-exchange loss and a $4,073 inventory adjustment in the first quarter. Additional gains or losses remain possible if currency conversion occurs at another rate.
The company reported material weaknesses in internal control over financial reporting relating to Brazilian indirect-tax controls and communication, and Indian system adoption and account reconciliation. Remediation was in progress, with full implementation anticipated by the end of 2014; there is no assurance that remediation will be successful.
The company faces a Brazilian indirect-tax assessment of approximately R$270,000 and estimated aggregate reasonably possible exposure of up to approximately $395,000 for material indirect-tax matters. The company had accrued approximately $26,000 for the Brazilian matter.
The company is appealing a July 2014 Thai Central Tax Court decision involving potential retroactive customs duties on imported ATMs and had not accrued an amount for that contingency.
Other risks include foreign-exchange volatility, customer and financial-institution spending, competitive and pricing pressures, technology acceptance, cybersecurity, pension funding, tax and regulatory developments, liquidity and the execution of the turnaround and outsourcing initiatives.

Important Facts for Investors to Verify

Whether operating improvements are sustainable after excluding the Eras gain and unusually high prior-year charges.
Progress toward the $150,000 realignment savings target and the timing and amount of remaining restructuring costs.
Conversion of improved accounting earnings into positive operating cash flow, particularly given growth in receivables, inventories and Brazil-related finance lease receivables.
Resolution and potential financial impact of the Brazilian indirect-tax assessment and Thai customs dispute.
Remediation of the disclosed material weaknesses in Brazil and India, including whether controls are operating effectively by year-end 2014.
Exposure to Venezuelan currency controls and further devaluation, as well as broader foreign-exchange effects.
Debt maturities, variable-rate exposure, covenant compliance and the availability of international cash for corporate needs.
The integration and strategic benefits of the Cryptera acquisition and the effect of increased research, development and transformation spending on future margins.