Diebold, Incorporated (NYSE: DBD) today reported second quarter 2005 revenue from continuing operations of $629.2 million, up 15.3 percent from the second quarter of 2004.
The company reported second quarter net income of $33.3 million, compared to net income of $43.6 million in the second quarter of 2004. Diluted earnings per share were $.47, a decline of 21.7 percent from $.60 per share in the second quarter of 2004 and within the most recent guidance of $.47 to $.50 per share.
Included in the second quarter 2005 reported results are restructuring charges of approximately $.03 per share and European Opteva manufacturing startup costs and related issues of $.04 per share. Excluding the impact of the restructuring charges and the European startup costs and related issues, diluted earnings per share in the second quarter would have been $.54 per share, consistent with previous guidance.
As previously announced on July 5, 2005, the company sold its campus card systems division. As a result, the financial results from this business have been classified as a discontinued operation.
Second Quarter Highlights
- Total product orders, excluding election systems and the Brazilian lottery business, grew in the high single-digit range led by double-digit growth in the Europe, Middle East and Africa (EMEA) region.
- The company secured a large order for lottery machines in Brazil for approximately $52 million.
- Total Opteva orders were approximately $131 million, an increase of more than 58 percent from the second quarter 2004.
- Security solutions revenue grew 25.0 percent and 24.1 percent on a fixed exchange-rate basis.
- Asia Pacific total revenue increased 49.9 percent, and 45.4 percent on a fixed exchange-rate basis.
- EMEA financial self-service revenue increased 14.2 percent, and 10.8 percent on a fixed exchange-rate basis.
- Receivable days sales outstanding improved 18 days, moving from 92 days at June 30, 2004 to 74 days at June 30, 2005.
"We are clearly disappointed with our profitability during the quarter," said Walden W. O'Dell, Diebold chairman and chief executive officer. "As we previously indicated, most of the markets in which we compete remain healthy and we once again experienced strong growth in orders and backlog during the quarter. However, slower than anticipated upgrade and replacement activity in the North America regional bank segment, cost challenges in our transition to a single global product platform, a higher mix of lower-margin revenue and negative foreign currency exchange impact due to the strengthening of the dollar in the quarter are negatively impacting our profit margins."
O'Dell added, "We are focused on improving the profitability of our business. In addition to previously disclosed cost-reduction actions, we are initiating some strategic changes within our organization. These changes are aimed at increasing the effectiveness of the functions across Diebold to better support our global efforts. The most sweeping of these changes is the establishment of a single Global Marketing organization, formed through consolidating several channel-based marketing functions. These changes will streamline our operations and drive improved efficiency and knowledge management throughout the company. Also, we have restructured our Global Software & Services organization by integrating all its functions into other existing organizations to better leverage resources and combine similar knowledge bases within the company.
"As a result of these and other actions, we anticipate cost reductions of approximately $20 million on an annual basis. I am confident that these structural changes to our organization, as well as our other cost-saving initiatives, will significantly improve our profitability and competitiveness in the marketplace."
Fixed Exchange-Rate Second Quarter Orders
Total orders for products and services increased in the high single-digit range, excluding election systems and Brazilian lottery equipment business during the second quarter. Financial self-service orders increased in the mid single-digit range, led by double-digit growth in EMEA. Security orders remain strong, increasing in the double-digit range. Orders in election systems increased significantly due to the previously disclosed equipment order in Ohio.
Total revenue from continuing operations for the quarter was $629.2 million, up $83.5 million, or 15.3 percent and 12.4 percent on a fixed exchange-rate basis. Total financial self-service revenue increased 11.7 percent and 8.0 percent on a fixed exchange-rate basis*. Security solutions revenue grew 25.0 percent and 24.1 percent on a fixed exchange-rate basis. Total financial self-service and security revenue increased by 15.0 percent and 12.0 percent on a fixed exchange-rate basis.
During the quarter, revenue was positively impacted by the year-over-year strengthening of the real, euro and certain other currencies. The positive currency impact in the second quarter was approximately $14.1 million or 2.6 percent versus the prior year reported results.
Total gross margin for the second quarter was 25.4 percent, compared to a strong 29.8 percent in the second quarter 2004. Included in total cost of sales in the second quarter 2005 was approximately $3.1 million of restructuring costs and $3.0 million of European Opteva manufacturing startup costs and related issues, which adversely impacted total gross margins by 1.0 percentage point.
Product gross margin was 27.4 percent, compared to 35.4 percent in the second quarter 2004. Included in product cost of sales in the second quarter of 2005 was approximately $2.5 million in restructuring charges and one-time special items of approximately $2.8 million, which adversely impacted product gross margins by 1.7 percentage points. Additionally, the decrease in product gross margins was attributable to a heavier mix of revenue derived from lower- margin businesses for the second quarter versus 2004. This includes a higher percentage of national account revenue in the United States, a greater mix of lower-margin international revenue, particularly from India and Thailand, and increased revenue from the security and election systems businesses.
Service gross margin was 23.4 percent, compared to 24.6 percent in the second quarter 2004. This decline was primarily the result of increased fuel costs. Included in the service cost of sales in the second quarter of 2005 was approximately $0.6 million in restructuring charges and $0.2 million in one-time special items, which adversely impacted service gross margins by 0.3 percentage points.
Total operating expenses for the quarter as a percent of revenue improved by 1.3 percentage points, moving to 16.6 percent from 17.9 percent in the second quarter 2004. Reduced selling, general and administrative expenses as a percentage of revenue accounted for 0.9 percentage points of the overall improvement to operating expenses. The improved leveraging of selling, general and administrative expenses was achieved due to aggressive controls on personnel costs and implementing a corporate-wide efficiency program. Reduced R&D expense resulting from ongoing product rationalization created by the Opteva rollout accounted for the balance of the improvement.
Operating profit was 8.8 percent of revenue, down 3.1 percentage points from 11.9 percent in the second quarter of 2004. Included in the financial results was $3.5 million of restructuring costs and $3.2 million of European Opteva manufacturing startup costs and related issues, which adversely impacted operating profits by 1.1 percentage points. Excluding the impact of these charges, operating profit margin would have been 9.9 percent in the second quarter 2005, a decrease of 2.0 percentage points from the second quarter 2004.
Other Expense and Minority Interest
Other expense and minority interest increased to $7.6 million in expense for the quarter from $2.1 million in expense in the second quarter of 2004. This increase was due mainly to the impact of higher foreign exchange losses of $2.7 million in the quarter and higher interest expense.
Net Income from Continuing Operations
Net income from continuing operations was 5.2 percent of revenue compared to 7.9 percent in the second quarter 2004. The decline in net income as a percent of revenue was partially the result of restructuring charges of $3.5 million and $3.9 million in special charges. Excluding the impact of these special charges net income from continuing operations would have been 6.0 percent. This decline from the prior year was attributable to unfavorable revenue mix from less profitable geographies and accounts.
Balance Sheet and Cash Flow Highlights
The company's net debt was $142.2 million at June 30, 2005 compared to $167.1 million at June 30, 2004. The $24.9 million decrease in net debt over the last 12 months was principally due to the positive impact of $225.7 million in free cash flow, partially offset by $74.5 million spent to repurchase company stock, $55.6 million in dividend payments, $45.0 million invested in acquisitions, $14.2 million in foreign exchange impact and $11.5 million invested in other assets.
In the second quarter, free cash use increased by $5.4 million, moving from a free cash use of $18.8 million in the second quarter of 2004 to $24.2 million in the second quarter of 2005. The increase in free cash use was due principally to higher capital expenditures, which increased by $5.6 million. DSO was 74 days at June 30, 2005, an 18-day improvement from 92 days at June 30, 2004. Inventory turns improved slightly from 5.0 at June 30, 2004 to 5.3 turns at June 30, 2005.
Stock Option and Restricted Stock Expense
As permitted under SFAS No. 123, "Accounting for Stock-Based Compensation," the company provides quarterly and annual disclosures of the impact to earnings per share if stock options were expensed. The company estimates that if stock options were expensed in accordance with SFAS No. 123 for the full year 2005, the impact would be approximately $.07 per share.
On December 15, 2004, the Financial Accounting Standards Board (FASB) issued Statement 123R, "Share-Based Payment," which now requires companies to measure compensation costs for all share-based payments (including employee stock options) at fair value. The deadline for adoption of Statement 123R is the first annual period beginning after June 15, 2005. The company has not yet quantified the impact of adoption of Statement 123R. The company intends to implement this standard in the first quarter 2006.
Company to file 10-Q/A and 10-K/A
As previously announced, the company identified a reconciliation issue in its North America sales commission accrual account. A detailed analysis of this reconciliation has been performed and the company has determined the commission account was under-accrued by $13.2 million at December 31, 2004 and $11.4 million at March 31, 2005. First quarter 2005 commission expense was overstated by $1.8 million. Commission expense in 2004 was understated by $0.3 million, with the first and second quarters of 2004 each understated by less than $0.1 million. Commission expense was understated by $2.7 million and $1.5 million in 2003 and 2002, respectively. The remaining $8.7 million understatement of commission expense was related to periods prior to fiscal year 2002. As a result, the company intends to file an amendment to its first quarter 2005 Form 10-Q and an amendment to its 2004 Form 10-K. All prior financial information presented in this release reflects the changes from the correction of the North America sales commission accrual account.
The following statements are based on current expectations. These statements are forward-looking and actual results may differ materially. These statements do not include the potential impact of any future mergers, acquisitions, disposals or other business combinations, or the effect of expensing stock options under the new accounting standard, SFAS Statement No. 123R "Share-Based Payment".
The company previously announced it anticipates full-year 2005 restructuring charges of $.15 to $.30, including the elimination of 300 full-time positions in North America and Western Europe, further global manufacturing realignment and facility consolidation and the consolidation of research and development operations and service functions.
At the end of the second quarter, the company had reported year-to-date restructuring charges of approximately $.10 per share. These charges include realignment of the company's operations in Western Europe and North America.
The company has identified a number of cost-reduction actions and now anticipates restructuring charges near the top end of the previously reported restructuring range, with charges of approximately $.20 identified for the remainder of 2005. These actions include:
- Additional global manufacturing realignment and facility consolidation to speed production and reduce costs
- Consolidation of research and development efforts to better serve key markets
- Merging software operations and combining various service functions to better leverage resources and expertise throughout the company
While the company will continue to realign operations, minimize operating costs and maximize existing resources, the planned elimination of the 300 full-time positions is nearly complete.
Third quarter 2005 outlook
Expectations for the third quarter 2005 include:
- Third quarter revenue is expected to increase 9 to 11 percent on a fixed exchange-rate basis.
- Financial self-service revenue growth of 7 to 9 percent.
- Security revenue growth of 10 to 12 percent.
- Election systems revenue is expected to be $35 to $45 million.
- The company anticipates manufacturing start-up and restructuring total charges in the range of $.07 to $.10 per share related to the continued realignment of its operations.
- Currency exchange is anticipated to impact revenue favorably by approximately 1.5 percent versus prior year.
- Depreciation and amortization to be approximately $20 million.
- An effective tax rate of approximately 32 percent.
- An increase in pension expense of approximately $.01 per share versus prior year.
- EPS in the range of $.72 to $.77 per share, including the anticipated manufacturing start-up costs and restructuring charges, and the one-time gain of approximately $.18 per share on the sale of the campus card systems business. Excluding manufacturing start-up costs and related issues as well as restructuring charges and the gain from the sale of the campus systems business, EPS is expected to be in the range of $.62 to $.67 per share.
Full-year 2005 outlook
Expectations for the full-year 2005 include:
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- Revenue growth of 10 to 12 percent, on a fixed exchange-rate basis.
- Financial self-service revenue growth of 6 to 8 percent.
- Security revenue growth of 17 to 19 percent.
- Election systems revenue is anticipated to be in the range of $115 to $125 million.
- Brazilian lottery systems revenue of $10 to $20 million.
- Currency expected to impact revenue favorably by approximately 1.2 percent versus prior year.
- Depreciation and amortization in the range of $75 to $80 million.
- An effective tax rate of approximately 32 percent.
- Pension expense is expected to be $.03 per share higher in 2005, moving from $.05 per share in 2004 to $.08 per share in 2005.
- Research and development expense will be approximately 2.5 percent of revenue, consistent with prior year.
- EPS to be $2.60 to $2.70. This range excludes restructuring charges of approximately $.30, manufacturing start-up costs and related issues of approximately $.04 per share, and the one-time gain of approximately $.18 per share on the sale of the campus card systems business.
- Free cash flow is expected to be in the range of $185 to $225 million.