Business Context and Reporting Period
Diebold, Incorporated filed its Form 10-K for the fiscal year ended December 31, 2013. The company provides financial self-service, security, software, outsourcing and managed services, primarily to financial, commercial, retail and government customers. It operated in more than 90 countries with approximately 16,000 employees and reported five geographic segments: North America, Asia Pacific, EMEA, Latin America and Brazil.
The filing includes fourth-quarter information, but the principal reporting period is the full year 2013. Beginning in the fourth quarter, management changed its segment structure to a regional geographic basis and restated prior-period segment information accordingly.
Key Financial Metrics
| Metric | 2013 | 2012 | Change |
|---|---|---|---|
| Net sales | $2.857 billion | $2.992 billion | Down 4.5% |
| Gross profit | $640.4 million | $729.6 million | Down 12.2% |
| Gross margin | 22.4% | 24.4% | Down 2.0 points |
| Operating profit/(loss) | $(118.3) million | $101.4 million | Decline of $219.7 million |
| Operating margin | (4.1)% | 3.4% | Down 7.5 points |
| Net income/(loss) attributable to Diebold | $(181.6) million | $73.6 million | Turned to loss |
| Diluted EPS | $(2.85) | $1.15 | Down $4.00 |
| Cash flow from operations | $124.2 million | $135.5 million | Down $11.3 million |
| Capital expenditures | $35.4 million | $49.7 million | Down $14.3 million |
| Dividends paid | $74.0 million | $72.8 million | Annualized dividend $1.15 per share |
Services represented 57.3% of sales, or $1.637 billion, and generated a 25.3% gross margin, unchanged from 2012. Product sales declined 10.6% to $1.220 billion, while product gross margin fell to 18.5% from 23.4%. International sales were $1.493 billion, or 52.3% of total sales.
At December 31, 2013, current assets were $1.555 billion and current liabilities were $893.7 million, producing net working capital of approximately $661.6 million. Cash and cash equivalents were $230.7 million, short-term investments were $243.0 million and total reported global liquidity was $798.4 million, including available credit facilities.
Total debt was approximately $524.0 million, consisting of $43.8 million of current notes payable and $480.2 million of long-term debt. Long-term debt decreased from $617.5 million at December 31, 2012. The company remained in compliance with its debt covenants. The five-year credit facility had $261.0 million of availability and expires in June 2016.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because North American financial self-service volume fell after the 2012 expiration of the Americans with Disabilities Act compliance deadline. Product sales and related installation and professional services were affected.
- Financial self-service revenue declined 4.1% to $2.217 billion; security revenue declined 0.8% to $618.9 million; election and lottery revenue declined 61.5% to $21.6 million.
- Asia Pacific revenue increased 12.1% and EMEA revenue increased 11.3%, while North America revenue decreased 11.0%, Latin America decreased 6.3% and Brazil decreased 7.9%, including significant unfavorable currency effects.
- Operating results were adversely affected by higher selling and administrative expense, restructuring charges, non-routine items and impairment charges. Research, development and engineering expense increased 7.5% to $92.3 million.
- The company recorded a $70.0 million pre-tax, non-cash goodwill impairment charge for Brazil after a reduced earnings outlook, deteriorating macroeconomic conditions, changes in auction-based purchasing and increased competition.
- The company recorded $57.0 million of restructuring charges, compared with $15.2 million in 2012, and $127.9 million of net non-routine expenses, including pension, FCPA, securities litigation and executive severance items.
- Cash from operations decreased modestly, while financing cash use increased to $204.4 million, principally because of $126.7 million of net debt repayments and higher distributions to noncontrolling interests.
- Goodwill declined from $273.0 million to $179.8 million, primarily due to the Brazil impairment and currency translation.
Guidance, Outlook, Commentary, Risks and Unusual Items
Strategy and Outlook
Management launched the multi-year “Diebold 2.0” turnaround strategy, focused on cost reduction, cash generation, talent, execution and sustainable profitable growth. The company expects hardware commoditization to continue and intends to increase the share of revenue derived from services and software to more than 60% during the transformation.
The multi-year realignment plan targets $150.0 million of savings to be fully realized by the end of 2015. Management expects approximately 50% of the savings to benefit operating profit, with the remainder reinvested in research and development, information technology, sales capabilities and back-office transformation. Additional restructuring costs of approximately $13 million to $16 million were expected through the end of 2014.
Management stated that available capital resources were expected to fund working capital, research and development, capital investments, pension contributions, dividends and potential share repurchases for at least the next 12 months. The filing does not provide formal earnings or revenue guidance.
Unusual and Nonrecurring Items
- $67.6 million non-cash pension charge associated with the voluntary early retirement program.
- $70.0 million non-cash goodwill impairment charge related to Brazil.
- $57.0 million of restructuring charges, including $31.3 million associated with the voluntary early retirement program.
- $28.0 million of additional pre-tax losses related to the FCPA investigation and settlement.
- $17.2 million net pre-tax charge related to settlement of a securities class action.
- $9.3 million of executive severance expense.
- The company paid $48.0 million to the U.S. government in November 2013 to settle SEC and DOJ FCPA matters and agreed to an independent compliance monitor for at least 18 months.
Principal Risks and Contingencies
- Management and KPMG reported material weaknesses in internal control over financial reporting involving Brazilian indirect-tax controls and communication, and adoption of a new ERP system and account reconciliations in India. The auditor issued an adverse opinion on internal control effectiveness, although the financial statements received an unqualified audit opinion.
- A Brazilian indirect-tax assessment was initially approximately $133.0 million, including penalties and interest. The company estimated aggregate potential exposure for material indirect-tax matters of up to approximately $395.0 million, against an accrual of approximately $26.0 million. The ultimate exposure remained uncertain and the matter could affect additional open tax years.
- Approximately 98.8% of cash and cash equivalents and short-term investments were held in international tax jurisdictions. Repatriation could generate additional tax costs, except for approximately $16.0 million already available for repatriation without additional tax expense.
- The company had $122.4 million of unfunded pension benefits at year-end and expected to contribute $4.6 million to pension plans and $1.7 million to other post-retirement plans in 2014. Future contributions could increase based on interest rates, asset returns and regulatory changes.
- Product backlog increased to approximately $728.8 million from $529.7 million, but management cautioned that orders may be canceled and that more than 50% of revenue is service revenue not captured in backlog.
- Key ongoing risks include foreign currency movements, economic weakness among financial institution customers, competitive pricing pressure, cybersecurity and systems integration risks, FCPA or other regulatory actions, goodwill impairment, tax exposures and the execution of the turnaround plan.
Important Facts for Investors to Verify
- Whether the Diebold 2.0 and $150.0 million realignment plan deliver the targeted savings and improve operating margins and free cash flow.
- Whether North American financial self-service demand recovers after the 2012 ADA-related volume comparison and whether product margins stabilize.
- Whether Brazil’s operating outlook improves and whether additional goodwill impairment or tax charges are required.
- Progress and final remediation of the Brazil and India material weaknesses in internal control over financial reporting.
- The final resolution and cash impact of the Brazilian indirect-tax assessment, including potential exposure of up to approximately $395.0 million across material indirect-tax matters.
- Liquidity after debt maturities, dividends, pension funding, restructuring payments and potential acquisitions or share repurchases.
- The sustainability of the $1.15 annualized dividend in light of the 2013 net loss and reduced cash generation.
- Whether international cash can be accessed without materially increasing tax expense and whether foreign exchange volatility continues to affect revenue and operating profit.