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DIEBOLD INC - 10-K - : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) OVERVIEW Management's discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes that appear elsewhere in this annual report on Form 10-K. Introduction The Company is a global leader in providing integrated services and software, financial self-service delivery and security systems to primarily the financial, commercial, retail and other markets. Founded in 1859, the Company today has approximately 16,000 employees with representation in more than 90 countries worldwide. The Company recently unveiled its multi-year turnaround strategy, Diebold 2.0, at the Investment Community Conference in November 2013. The objective of Diebold 2.0 is to transform the Company into a world-class, services-led and software enabled provider of secure, convenient and efficient solutions for its customers. The turnaround strategy will follow a "Crawl, Walk, Run" approach, which requires the core business operations to be stabilized in the "Crawl" phase and build the foundation for future growth in the "Walk" and "Run" phases. Four core pillars provide the Company a clear path toward reaching this multi-year objective: • Reduce its cost structure and improve its near-term delivery and execution. • Generate increased free cash flow in order to fund the investments necessary to drive profitable growth, while preserving the ability to return value to shareholders in the form of reliable dividends and, as appropriate, share repurchases. • Attract and retain the talent necessary to drive innovation and the focused execution of the transformation strategy. • Return the Company to a sustainable, profitable growth trajectory. The Company sees opportunities to leverage its capabilities in services, software and innovation to meet the needs of its rapidly evolving markets. The Company has sharpened its focus on executing its core strategies in FSS and electronic security. This includes making the appropriate investments to deliver growth within these areas. In addition, the Company remains committed to a disciplined risk assessment process, focused on proactively identifying and mitigating potential risks to the Company's continued success. (Loss) income from continuing operations attributable to Diebold, Incorporated, net of tax, for the year ended December 31, 2013 was $(181,605), or $(2.85) per share, a decrease of $258,333, or $4.05 per share from the year ended December 31, 2012. Total revenue for the year ended December 31, 2013 was $2,857,491, a decrease of $134,202 from the year ended December 31, 2012. The year ended December 31, 2013 included a $67,593 pre-tax non-cash pension charge related to the voluntary early retirement program, a $70,000 pre-tax goodwill impairment charge, $57,015 of pre-tax restructuring charges related to the Company's multi-year realignment plan, including $31,282 related to the voluntary early retirement program, $28,000 of additional pre-tax losses related to the settlement of the global FCPA investigation, a $17,245 pre-tax net charge related to settlement of the securities class action, and $9,300 of pre-tax executive severance. Additionally, a significant portion of the decline was associated with lower volume in NA resulting from the expiration of the Americans with Disabilities Act (ADA) compliance deadline in 2012. Internationally, improvement was driven by higher FSS sales in AP and EMEA combined with security sales growth in Brazil, mainly due to the GAS Tecnologia (GAS) acquisition in Brazil. These increases were partially offset by a reduction in election systems and lottery sales in Brazil as well as a decline in FSS volume for LA. Additionally, the 2013 results were significantly impacted by a higher tax rate, which is a result of tax expense related to the repatriation of previously undistributed earnings and the establishment of a valuation allowance on certain Brazil deferred tax assets. Diebold 2.0 - Turnaround Strategy The Company's turnaround strategy, Diebold 2.0, is built on four core pillars: cost, cash, talent and growth. Underpinned by the four core pillars, the turnaround strategy encompasses eight specific actions to achieve top-tier performance and generate sustainable, profitable growth. 21-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Eight-Point Program: 1. Establish a Competitive Cost Structure Reducing the Company's fixed cost envelope and driving operational rigor is fundamental. The $150,000 multi-year realignment plan launched in 2013 will drive efficiency while reducing general and administrative costs and the cost of goods sold. 2. Drive Sustainable Improvement in Cash Flow The Company is committed to improving cash generation in order to increase shareholder value and fuel the investments necessary to grow the business. An emphasis on working capital improvements and cash generation now extends far beyond the finance organization - it is a main-stage requirement in every operation in every region. 3. Improve Sales Effectiveness The Company's sales teams must enhance skills, tools and coverage to reach more prospects more effectively. For example, the global deployment of Salesforce.com will enhance the ability to plan, forecast and allocate resources more productively. 4. Increase Speed and Agility Streamlining the management structure will drive greater accountability, accelerate decision-making and facilitate the transition to a truly global business. Change is being viewed as an enabler of progress and not as a disrupter. 5. Instill a Winning Culture Grounded in Execution The message being driven to every member of the organization: The Company is not merely to participate in a market, but to succeed, and win through a culture built upon accountability and execution. As an example, the Company is taking steps to better align employee compensation with Company performance. 6. Collaborate With Customers and Partners to Drive Innovative Solutions The Company must accelerate new ideas through teamwork with capable partners and collaboration with customers. For example, the India-originated Diebold 429 ATM solution reduced development time and costs while at the same time meeting defined market needs. 7. Further Leverage Services and Software The Company expects the commoditization of hardware to continue, the size and importance of the software stack to increase, and our expertise in services and system integration to be a key differentiator. The objective is to further expand the percentage of sales derived from services and software, which is expected to exceed 60 percent during the transformation. 8. Generate Long-Term, Profitable Growth The seven actions defined above are designed to put the Company on a sustainable, profitable growth trajectory. A commitment to operational rigor, improved analytics and data-driven decision-making is expected to position the Company to benefit from secular trends in outsourcing and mobility, expand its electronic security business and drive both organic and inorganic growth. Solutions The Company leverages its strong base of maintenance and advanced services to deliver comprehensive outsourcing and managed services. Banks are continuously being challenged to reduce costs while increasing operational efficiencies. Through outsourced services, banks entrust the management of their ATM and security operations to the Company, allowing their staffs to focus on core competencies. Furthermore, the Company's outsourcing and managed services offering provides banks and credit unions with the leading-edge technology they need to stay competitive in the marketplace. As a leader in outsourcing services, the Company is poised to capitalize on the secular outsourcing trends in the marketplace. Several years ago, the Company launched its outsourcing and managed services business in North America and has grown this business from $5,000 to over $200,000 in annual revenue with over 22,500 units under contract. 22-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Another demand driver in the global ATM marketplace is branch transformation. The concept of branch transformation is to help financial institutions reduce their costs by migrating routine transactions, typically done inside the branch, to lower-cost automated channels, including the ATM. One area of branch transformation that continues to gain traction is deposit automation. Among the largest U.S. national banks, there has been extensive deployment of deposit automation-enabled terminals. Today, approximately 25 percent of ATMs globally are configured for automated deposits. Another solution the Company offers as part of its branch transformation efforts is Concierge Video Services™, most recently launched in North America. The solution provides consumers with on-demand access to bank call center representatives right at the ATM for sales or bank account maintenance support. In addition to delivering a personal touch outside of regular business hours, Concierge Video Services™ ultimately assists financial institutions by maximizing operational efficiencies, improving the consumer experience and enhancing the overall consumer relationship. Mobile integration is another emerging trend in the FSS space, as consumers look for multiple ways to interact with their financial institutions. In July 2013, Diebold introduced its cardless Mobile Cash Access solution, which allows consumers to stage a transaction with their mobile device and complete it at the ATM without the need for a card. This capability provides consumers with a more convenient and secure option, while giving financial institutions the opportunity to offer their own branded mobile wallet solution. In its security business, the Company has another opportunity for a successful outsourcing and managed services approach. Security challenges and the systems to address them have grown increasingly complex. That has created a strong business case among financial institutions and commercial customers for outsourcing and managed service solutions, particularly in the areas of monitoring, services and software management. Today, the Company is bringing its expertise back into the financial sector and pursuing other areas, namely the commercial market, with a focused effort to secure large, complex and technologically demanding projects. The Company has customer-focused teams that possess high levels of logical and enterprise security expertise that are required in this business. The Company is also leveraging best practices and some of the best talent to continue building upon its security outsourcing and manged services business. As it relates to security, the Company recently introduced a new online security management tool in in North America, called SecureStat®, that streamlines how customers manage their security operations. At the core of the solution is a personalized dashboard that utilizes customizable, distinct widgets to provide a snapshot of a user's entire security platform, including locations, security systems and devices. In addition, SecureStat® can unify security services and disparate systems, while providing a single interface for real-time administration of security operations across an enterprise. SecureStat® is a great example of the software-driven platforms the Company is investing in to strengthen its services offering and differentiate itself in the marketplace. Moving forward, the Company intends to create shareholder value by leveraging the opportunities it sees within the area of branch transformation, growing its services, outsourcing and software capabilities, further building out its electronic security business and taking advantage of key secular trends around the world. Many opportunities lie ahead, and the Company will continue to invest in developing new services, software and security solutions that align with the needs of its core markets. Multi-Year Realignment Plan The Company is committed to its previously announced multi-year realignment plan aimed at establishing a competitive cost structure throughout the organization. The Company has currently identified targeted savings of $150,000 that are expected to be fully realized by the end of 2015 and is working to accelerate the cost savings efforts beyond this target longer-term. The Company expects to reinvest a portion of the savings to drive long-term growth. Areas of reinvestment include: research and development of innovative new customer solutions; improving and updating the Company's information technology systems and infrastructure; transforming the general and administrative back-office functions; and strengthening sales coverage, processes and tools. In addition, some of the savings should offset price erosion, wage inflation in emerging markets and volatile commodity prices in the Company's core business. Given these factors, the Company anticipates that approximately 50 percent of the savings will positively impact operating profit. In addition to the cost savings impact, the plan will enhance its competitive position by focusing on globalizing the Company's service organization, creating a unified center-led global organization for research and development as well as transform the Company's general and administrative cost structure. Restructuring charges associated with the multi-year realignment plan were $57,015 and $15,241 for 2013 and 2012, respectively. 23-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Segment Reporting In the fourth quarter of 2013, the Company began managing its business on a regional geographic basis, changing from the previous model, which was a more condensed geographic basis. In order to align the Company's external reporting of its financial results with this change, the Company has modified its segment reporting. The Company now reports the following five segments: NA, AP, EMEA, LA and Brazil. Business Drivers The business drivers of the Company's future performance include, but are not limited to: • timing of self-service equipment upgrades and/or replacement cycles, including deposit automation in mature markets such as the United States; • demand for products and solutions related to bank branch transformation opportunities; • demand for services, including outsourcing and managed services; • demand for security products and services for the financial and commercial sectors; and • high levels of deployment growth for new self-service products in emerging markets, such as AP. 24-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) The table below presents the changes in comparative financial data for the years ended December 31, 2013, 2012 and 2011. Comments on significant year-to-year fluctuations follow the table. The following discussion should be read in conjunction with the consolidated financial statements and the accompanying notes that appear elsewhere in this annual report on Form 10-K. Year ended December 31, 2013 2012 2011 % of % of % of Net Net Net Sales % Change Sales % Change Sales Net sales Services $ 1,637,056 57.3 0.6 $ 1,626,521 54.4 4.8 $ 1,552,358 54.7 Products 1,220,435 42.7 (10.6) 1,365,172 45.6 6.4 1,283,490 45.3 2,857,491 100.0 (4.5) 2,991,693 100.0 5.5 2,835,848 100.0 Cost of sales Services 1,222,675 42.8 0.6 1,215,673 40.6 6.8 1,138,213 40.1 Products 994,460 34.8 (5.0) 1,046,400 35.0 8.2 967,161 34.1 2,217,135 77.6 (2.0) 2,262,073 75.6 7.4 2,105,374 74.2 Gross profit 640,356 22.4 (12.2) 729,620 24.4 (0.1) 730,474 25.8 Selling and administrative expense 596,694 20.9 13.1 527,729 17.6 4.6 504,436 17.8 Research, development and engineering expense 92,315 3.2 7.5 85,881 2.9 10.0 78,108 2.8 Impairment of assets 72,017 2.5 356.3 15,783 0.5 432.8 2,962 0.1 Gain on sale of assets, net (2,410 ) (0.1) 100.5 (1,202 ) - (37.4) (1,921 ) (0.1) 758,616 26.5 20.8 628,191 21.0 7.6 583,585 20.6 Operating (loss) profit (118,260 ) (4.1) (216.6) 101,429 3.4 (30.9) 146,889 5.2 Other (expense) income, net (1,547 ) (0.1) (116.3) 9,466 0.3 (21.4) 12,048 0.4 (Loss) income from continuing operations before taxes (119,807 ) (4.2) (208.0) 110,895 3.7 (30.2) 158,937 5.6 Income tax expense 56,715 2.0 100.9 28,225 0.9 251.6 8,028 0.3 (Loss) income from continuing operations (176,522 ) (6.2) (313.5) 82,670 2.8 (45.2) 150,909 5.3 (Loss) income from discontinued operations, net of tax - - (100.0) (3,125 ) (0.1) N/M 523 - Net (loss) income (176,522 ) (6.2) (321.9) 79,545 2.7 (47.5) 151,432 5.3 Net income attributable to noncontrolling interests 5,083 0.2 (14.5) 5,942 0.2 (18.4) 7,285 0.3 Net (loss) income attributable to Diebold, Incorporated $ (181,605 ) (6.4) (346.7) $ 73,603 2.5 (48.9) $ 144,147 5.1 Amounts attributable to Diebold, Incorporated (Loss) income from continuing operations, net of tax $ (181,605 ) (6.4) $ 76,728 2.6 $ 143,624 5.1 (Loss) income from discontinued operations, net of tax - - (3,125 ) (0.1) 523 - Net (loss) income attributable to Diebold, Incorporated $ (181,605 ) (6.4) $ 73,603 2.5 $ 144,147 5.1 25-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) RESULTS OF OPERATIONS 2013 comparison with 2012 Net Sales The following table represents information regarding our net sales for the years ended December 31: 2013 2012 $ Change % Change Total financial self-service 2,216,968 2,311,901 (94,933 ) (4.1) Total security 618,889 623,637 (4,748 ) (0.8) Election and lottery systems 21,634 56,155 (34,521 ) (61.5) Total net sales $ 2,857,491 $ 2,991,693 $ (134,202 ) (4.5) The decrease in FSS sales included a net unfavorable currency impact of $40,920 or 1.7 percent, of which approximately 76 percent related to the Brazilian real. The following segment highlights include the impact of foreign currency. NA FSS sales decreased $167,104 or 15.9 percent due primarily to lower volume within the U.S. regional bank business partially offset by growth in the national bank sector. A significant portion of the decline was associated with the expiration of the ADA compliance deadline in 2012. The product volume decrease in regional bank business caused a corresponding reduction in the service business specific to installation and professional services sales. AP increased $56,544 or 14.1 percent due to higher volume in India and China. EMEA increased $36,125 or 11.1 percent mainly from higher volume in Western Europe and the Middle East primarily in the emerging market of Turkey due in part to the Altus acquisition partially offset by a net decrease in the remainder of the region. Brazil decreased $13,058 or 3.9 percent, including $31,020 in unfavorable currency impact. LA declined $7,440 or 3.7 percent mainly due to volume deterioration in Mexico, partially offset by an increase in Colombia. Security sales decreased from declines in the LA, NA and AP regions. LA decreased $8,869 or 15.2 percent largely due declines in Chile. NA experienced a reduction of $8,378 or 1.6 percent. AP decreased $4,960 or 19.7 percent as the company executed on its decision in 2013 to exit the security business in Australia. These reductions were partially offset by Brazil increasing from the prior year due to the GAS acquisition. The decrease in the Brazilian-based election and lottery systems was driven by cyclical purchasing decisions within the country. Gross Profit The following table represents information regarding our gross profit for the years ended December 31: 2013 2012 $ Change % Change Gross profit - services $ 414,381 $ 410,848 $ 3,533 0.9 Gross profit - products 225,975 318,772 (92,797 ) (29.1) Total gross profit $ 640,356 $ 729,620 $ (89,264 ) (12.2) Gross margin - services 25.3 % 25.3 % Gross margin - products 18.5 % 23.4 % Total gross margin 22.4 % 24.4 % Total service gross margin remained at 25.3 percent in 2013. NA service gross margin increased due to improvements resulting from lower employee related expense associated with restructuring initiatives and a decrease in insurance and vehicle related expense in the U.S. maintenance business. In addition, NA benefited from stronger performance in the enterprise security business. These benefits were partially offset by lower FSS product volume within the U.S. regional business related to the expiration of the ADA compliance deadline in 2012, which negatively impacted services utilization specific to professional service and installation. Total service gross margin also benefited from higher volume and improved margins in EMEA and AP, partially offset by a margin decrease in Brazil. Total service gross profit in 2013 and 2012 included restructuring charges of $27,107 and $6,226, respectively. 26-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) The decrease in total product gross margin was driven by NA, which had significantly lower volume, particularly in the U.S. regional bank business, due to the expiration of the ADA compliance deadline in 2012. In addition, the decline in U.S regional bank business coupled with an increase in U.S. national bank sales created a customer mix shift that contributed to the product margin deterioration. Total product gross margin was also negatively influenced by unfavorable customer mix and continued pricing pressure in AP while there was a partially offsetting improvement in EMEA mainly due to favorable manufacturing performance resulting primarily from beneficial currency impact on material purchase prices. Total product gross profit included restructuring charges of $1,256 in 2013 compared to a net restructuring accrual benefit of $1,849 in 2012. Operating Expenses The following table represents information regarding our operating expenses for the years ended December 31: 2013 2012 $ Change % Change Selling and administrative expense $ 596,694 $ 527,729 $ 68,965 13.1 Research, development and engineering expense 92,315 85,881 6,434 7.5 Impairment of assets 72,017 15,783 56,234 356.3 Gain on sale of assets, net (2,410 ) (1,202 ) 1,208 100.5 Total operating expenses $ 758,616 $ 628,191 130,425 20.8 The increase in selling and administrative expense resulted from higher non-routine expense and restructuring charges, partially offset by lower compensation and commission related expense, savings realized from the Company's continued focus on cost structure and favorable currency impact of $6,240. Non-routine expenses of $128,739 and $41,542 were included in 2013 and 2012, respectively. The primary components of the 2013 non-routine expense were a $67,593 non-cash pension charge, additional losses of $28,000 related to the settlement of the FCPA investigation, $17,245 related to the settlement of the securities class action and executive severance costs of $9,300. The majority of the 2012 non-routine expense pertained to $21,907 in early pension buy-out payments made to certain deferred terminated vested participants and estimated losses of $16,750 related to the FCPA investigation. Selling and administrative expense also included $22,561 and $9,037 of restructuring charges in 2013 and 2012, respectively. Restructuring charges in 2013 related to the Company's multi-year realignment plan, including $31,282 related to the voluntary early retirement program. The 2012 restructuring charges related to the Company's global realignment and global shared services plans. Research, development and engineering expense as a percent of net sales in 2013 and 2012 were 3.2 percent and 2.9 percent, respectively. The spend increase between years resulted from higher restructuring charges and higher expense related to software development in 2013. Research, development and engineering expense included restructuring charges of $6,091 and $1,827 in 2013 and 2012, respectively. During the third quarter of 2013, the Company performed an other-than-annual assessment for its Brazil reporting unit based on a two-step impairment test as a result of a reduced earnings outlook for the Brazil business unit due to deteriorating macro-economic outlook, structural changes to an auction-based purchasing environment and new competitors entering the market. The Company concluded that the goodwill within the Brazil reporting unit was partially impaired and recorded a $70,000 pre-tax, non-cash goodwill impairment charge. During the second quarter of 2012, the Company impaired previously capitalized software and software-related costs of $6,701 due to changes in the global enterprise resource planning (ERP) system implementation plan related to configuration and design. In the third quarter of 2012, the Company recorded an impairment of $7,930 related to its 50 percent ownership in Shanghai Diebold King Safe Company, Ltd. 27-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Operating (Loss) Profit The following table represents information regarding our operating (loss) profit for the years ended December 31: 2013 2012 $ Change % Change Operating (loss) profit $ (118,260 ) $ 101,429 $ (219,689 ) (216.6) Operating (loss) profit margin (4.1 )% 3.4 % The decline in operating (loss) profit was influenced primarily by lower volume and a shift in customer mix within NA and significant increases in impairment, non-routine expenses and restructuring charges, partially offset by lower operational spend in NA and an overall improvement in service margin. Other Income (Expense) The following table represents information regarding our other income (expense) for the years ended December 31: 2013 2012 $ Change % Change Investment income $ 27,603 $ 37,593 $ (9,990 ) (26.6) Interest expense (29,234 ) (30,330 ) (1,096 ) (3.6) Foreign exchange gain, net 172 2,654 (2,482 ) (93.5) Miscellaneous, net (88 ) (451 ) (363 ) (80.5) Other income (expense) $ (1,547 ) $ 9,466 (11,013 ) (116.3) The decline in investment income was primarily driven by Brazil due to a decrease in total investments, lower interest rates and unfavorable currency impact. Foreign exchange gain, net, in 2013 included a $1,584 devaluation of the Venezuelan balance sheet. (Loss) Income from Continuing Operations The following table represents information regarding our (loss) income from continuing operations, net of tax for the years ended December 31: 2013 2012 $ Change % Change (Loss) income from continuing operations, net of tax $ (176,522 ) $ 82,670 $ (259,192 ) (313.5) Percent of net sales (6.2 )% 2.8 % Effective tax rate (47.3 )% 25.5 % The decrease in (loss) income from continuing operations, net of tax was driven by reduced operating profit mostly related to the decrease in sales volume and the significant increases in impairment, non-routine expenses and restructuring charges, unfavorable movement in other (expense) income and higher taxes. These decreases were partially offset by lower operational spend and an improvement in service margin. The negative tax rate for 2013 is a result of tax expense of approximately $55,000 related to the repatriation of previously undistributed earnings and the establishment of a valuation allowance of approximately $39,200 on deferred tax assets in the Company's Brazilian manufacturing facility. The 2013 tax rate was also negatively impacted by the partially non-deductible Brazil goodwill impairment and the FCPA penalty charge. 28-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Segment Revenue and Operating Profit Summary The following tables represent information regarding our revenue and operating profit by reporting segment for the years ended December 31: North America: 2013 2012 $ Change % Change Revenue $ 1,415,050 $ 1,590,532 $ (175,482 ) (11.0) Segment operating profit 252,737 294,996 (42,259 ) (14.3) Segment operating profit margin 17.9 % 18.5 % The decrease in revenue and operating profit was driven by lower FSS product volume in the U.S. regional bank business associated with the expiration of the ADA compliance deadline in 2012. The product volume decrease in regional bank business caused a corresponding reduction in the service business specific to installation and professional services. These detriments were partially offset by lower compensation and commission related expense, savings realized from the Company's continued focus on cost structure, and margin improvement in the U.S. maintenance business resulting from restructuring initiatives and growth in the national bank business. Asia Pacific: 2013 2012 $ Change % Change Revenue $ 479,129 $ 427,542 $ 51,587 12.1 Segment operating profit 62,760 62,414 346 0.6Segment operating profit margin 13.1 % 14.6 % Revenue growth resulted from higher product and service sales primarily within India and China. Operating profit remained neutral to prior year as higher service gross profit resulting from the increased sales and improved service margin performance was offset by a reduction in product gross profit and higher operating expense. Total product gross profit was negatively impacted by unfavorable customer mix and continued pricing pressure in the region. Europe, Middle East and Africa: 2013 2012 $ Change % Change Revenue $ 362,167 $ 325,489 $ 36,678 11.3 Segment operating profit 44,507 28,659 15,848 55.3Segment operating profit margin 12.3 % 8.8 % Revenue increased from growth in Western Europe and the Middle East due in part to the Altus acquisition in Turkey, partially offset by a net decline in the rest of EMEA. The increase in operating profit resulted from higher product and service sales complemented by improved margins especially on the product side mainly due to favorable manufacturing performance resulting primarily from beneficial currency impact on material purchase prices. These favorable influences on operating profit were partially offset by higher selling and administrative expense. Latin America: 2013 2012 $ Change % Change Revenue $ 241,770 $ 258,079 $ (16,309 ) (6.3) Segment operating profit 35,218 44,472 (9,254 ) (20.8)Segment operating profit margin 14.6 % 17.2 % Revenue declined as lower product sales, primarily due to decreased volume in Mexico and Venezuela, was partially offset by higher sales in the service business. Operating profit was negatively impacted by the net revenue decrease coupled with an overall gross margin decline and higher operating expense. Brazil: 2013 2012 $ Change % Change Revenue $ 359,375 $ 390,051 $ (30,676 ) (7.9) Segment operating profit 6,321 3,304 3,017 91.3Segment operating profit margin 1.8 % 0.8 % The decrease in revenue included a net unfavorable currency impact of $36,722. Excluding the negative currency impact, revenue increased from higher FSS sales and growth in security revenue due to the GAS acquisition, partially offset by lower lottery and 29-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) election systems sales. Operating profit increased as the benefit of lower operating expense outweighed the unfavorable impact of the total revenue decline between years. Refer to note 19 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K, for further details of segment revenue and operating profit. 2012 comparison with 2011 Net Sales The following table represents information regarding our net sales for the years ended December 31: 2012 2011 $ Change % Change Total financial self-service 2,311,901 2,137,545 174,356 8.2 Total security 623,637 605,502 18,135 3.0 Election and lottery systems 56,155 92,801 (36,646 ) (39.5) Total customer revenues $ 2,991,693 $ 2,835,848 $ 155,845 5.5 The increase in FSS sales included a net unfavorable currency impact of $85,545 or 4.5 percent, of which approximately 56 percent related to the Brazilian real. The following segment highlights include the impact of foreign currency. NA sales increased $181,576 or 20.9 percent as a result of significant growth within the U.S. regional and national bank business influenced by the ADA compliance and a focus on deposit automation technology. With the expiration of the ADA compliance deadline, the rate of growth in regional sales has slowed and led to a higher concentration of national bank sales. EMEA decreased $20,085 or 5.8 percent driven by an unfavorable currency impact, particularly the euro and South African rand, partially offset with growth in South Africa compared to the prior year. Brazil FSS sales declined $13,540 or 3.9 percent due to unfavorable currency impact of $47,522, partially offset by higher volume. LA increased $22,769 or 12.9 percent due to higher volume across most of the geographies. AP increased $3,637 or 0.9 percent driven by higher volume in Thailand, partially offset by an unfavorable currency impact associated mostly with the Indian rupee. The security sales increase resulted mainly from growth in LA of $12,742 or 27.9 percent associated with higher volume in Colombia and Chile. NA security sales increased $3,938 or 0.7 percent compared to the prior year. The improvement in NA security sales was driven from an increase in infrastructure projects for government agency and commercial customers, partially offset by lower volume with financial customers compared to the prior year. The Brazilian-based election and lottery systems sales in 2012 decreased by $36,646 or 39.5 percent compared to 2011, inclusive of a $13,608 net unfavorable currency impact. The decrease was driven by a $46,116 reduction in election system sales primarily due to lower volume, partially offset by an increase in lottery unit sales compared to 2011. Gross Profit The following table represents information regarding our gross profit for the years ended December 31: 2012 2011 $ Change % Change Gross profit - services 410,848 414,145 (3,297 ) (0.8) Gross profit - products 318,772 316,329 2,443 0.8 Total gross profit $ 729,620 $ 730,474 $ (854 ) (0.1) Gross margin - services 25.3 % 26.7 % Gross margin - products 23.4 % 24.6 % Total gross margin 24.4 % 25.8 % The decrease in total service gross margin for 2012 compared to 2011 was driven by margin decreases in each region with the exception of EMEA, which improved due to fewer net restructuring charges in 2012 paired with a favorable customer mix. NA was the primary driver of the margin decrease due to an increased competitive environment and associated pricing impact coupled with higher compensation and benefits, scrap and insurance charges. Brazil was also down from an increase in warranty expense 30-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) combined with higher restructuring charges in 2012. Total service gross profit for 2012 included $6,226 of net restructuring charges compared to $10,678 of net restructuring charges in 2011. The decrease in total product gross margin was driven by product and customer mix differences in Brazil, as well as continued pricing pressure in AP. Partially offsetting these decreases, NA product revenue was significantly higher in 2012 compared to 2011, which caused a favorable shift in revenue mix among the regions, improving product gross margin. Total product gross profit for 2012 included $1,849 of net restructuring accrual benefits compared to $3,905 of net restructuring charges in 2011 related mainly to the EMEA reorganization. Operating Expenses The following table represents information regarding our operating expenses for the years ended December 31: 2012 2011 $ Change % Change Selling and administrative expense $ 527,729 $ 504,436 $ 23,293 4.6 Research, development and engineering expense 85,881 78,108 7,773 10.0 Impairment of assets 15,783 2,962 12,821 432.8 Gain on sale of assets, net (1,202 ) (1,921 ) (719 ) (37.4) Total operating expenses $ 628,191 $ 583,585 44,606 7.6 The increase in selling and administrative expense was due to higher non-routine expenses, compensation and benefits increase and legal expenses, partially offset by a favorable currency impact of $13,848 and lower restructuring charges. Selling and administrative expense in 2012 and 2011 included non-routine expenses of $41,542 and $16,480, respectively. Non-routine expenses in 2012 included $21,907 related to early pension buy-out payments made to certain deferred terminated vested participants and estimated losses of $16,750 related to the FCPA investigation. The non-routine expenses in 2011 pertained to legal, consultative and audit costs related to the global FCPA investigation as well as estimated losses of $3,250 related to this matter. In addition, selling and administrative expense included $9,037 and $11,607 of restructuring charges in 2012 and 2011, respectively. The 2012 restructuring charges related to the Company's global realignment and global shared services plans. The 2011 restructuring charges related mainly to the EMEA reorganization. Research, development and engineering expense as a percent of net sales in 2012 and 2011 were 2.9 percent and 2.8 percent, respectively. The increase in operational spend was associated with key initiatives such as the development of next generation hardware and software platforms. Research, development and engineering expense also included higher restructuring charges associated with the Company's global realignment plan. During the second quarter of 2012, the Company impaired previously capitalized software and software-related costs of $6,701 due to changes in the global ERP system implementation plan related to configuration and design. In the third quarter of 2012, the Company recorded an impairment of $7,930 related to its 50 percent ownership in Shanghai Diebold King Safe Company, Ltd. The impairment charge of $2,962 in 2011 resulted from a non-cash intangible asset impairment related to a prior acquisition. Operating Profit The following table represents information regarding our operating profit for the years ended December 31: 2012 2011 $ Change % Change Operating profit $ 101,429 $ 146,889 $ (45,460 ) (30.9) Operating profit margin 3.4 % 5.2 % The decrease in operating profit in 2012 compared to 2011 was influenced by a decrease in both service and product gross margins paired with the increase in operating expenses partially offset by the benefit of higher volume. All of these items combined to produce a 1.8 percentage point decrease in operating profit margin in 2012 compared to 2011. 31-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Other Income (Expense) The following table represents information regarding our other income (expense) for the years ended December 31: 2012 2011 $ Change % Change Investment income $ 37,593 $ 41,663 $ (4,070 ) (9.8) Interest expense (30,330 ) (34,456 ) (4,126 ) (12.0) Foreign exchange gain, net 2,654 3,095 (441 ) (14.2) Miscellaneous, net (451 ) 1,746 (2,197 ) (125.8) Other income (expense) $ 9,466 $ 12,048 (2,582 ) (21.4) Investment income declined in 2012 from the influence of a net unfavorable currency impact. Interest expense in 2012 decreased compared to 2011 due to lower interest rates and favorable foreign exchange hedge activity. Income from Continuing Operations The following table represents information regarding our income from continuing operations, net of tax for the years ended December 31: 2012 2011 $ Change % Change Income from continuing operations, net of tax $ 82,670 $ 150,909 $ (68,239 ) (45.2) Percent of net sales 2.8 % 5.3 % Effective tax rate 25.5 % 5.1 % The decrease in income from continuing operations, net of tax in 2012 compared to 2011 was driven by the reduction in operating profit margin, a decrease in other income and the increase in the effective tax rate. The 20.4 percentage point increase in the effective tax rate was due to the 2011 benefit of valuation allowance released in Brazil, offset by 2012 net income in jurisdictions with a lower tax rate. Segment Revenue and Operating Profit Summary The following tables represent information regarding our revenue and operating profit by reporting segment for the years ended December 31: North America: 2012 2011 $ Change % Change Revenue $ 1,590,532 $ 1,405,018 $ 185,514 13.2 Segment operating profit 294,996 276,546 18,450 6.7Segment operating profit margin 18.5 % 19.7 % The increase in revenue was primarily driven by growth in the FSS business, particularly related to higher product volume in both the U.S. regional and national bank business. The higher FSS product volume influenced growth in service installations and software-led services. Partially offsetting these revenue increases was a reduction in security product volume in the U.S. national bank business. Operating profit benefited from the higher net sales volume while being negatively impacted by an increase in operating expense and a decrease in total gross margin due in part to lower margin in traditional maintenance services related to competitive pricing and higher compensation and benefits, scrap, and insurance charges. 32-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Asia Pacific: 2012 2011 $ Change % Change Revenue $ 427,542 $ 422,491 $ 5,051 1.2 Segment operating profit 62,414 74,790 (12,376 ) (16.5) Segment operating profit margin 14.6 % 17.7 % Revenue increased due to a mix of revenue shifts among the AP countries with the most significant growth in Thailand. Operating profit decreased despite the revenue growth due to higher operating expense as well as service and product gross margin deterioration of which product declined principally due to continued pricing pressure. Europe, Middle East and Africa: 2012 2011 $ Change % Change Revenue $ 325,489 $ 345,534 $ (20,045 ) (5.8) Segment operating profit 28,659 15,978 12,681 79.4Segment operating profit margin 8.8 % 4.6 % The revenue decrease, inclusive of a net unfavorable currency impact of $25,425, occurred among a majority of the countries within both the product and service businesses. The unfavorable impact of lower revenue on operating profit was more than offset by a significant decrease in operating expense and improved gross margins particularly in service. Latin America: 2012 2011 $ Change % Change Revenue $ 258,079 $ 222,568 $ 35,511 16.0 Segment operating profit 44,472 40,425 4,047 10.0Segment operating profit margin 17.2 % 18.2 % The increase in revenue was due to higher FSS and security sales across most of the countries in the region. The volume gain paired with improved gross margin performance in the security business increased operating profit. These benefits to operating profit were partially offset by lower gross margin in the FSS business and higher selling and administrative expense. Brazil: 2012 2011 $ Change % Change Revenue $ 390,051 $ 440,237 $ (50,186 ) (11.4) Segment operating profit 3,304 36,119 (32,815 ) (90.9)Segment operating profit margin 0.8 % 8.2 % Revenue was negatively impacted by net unfavorable currency impacts of $61,133. From an operational perspective, revenue increased $10,947 or 2.9 percent as higher FSS volume and lottery unit sales outweighed a decline in the election systems business. The decrease in operating profit resulted from customer and product mix differences, fewer election system sales compared to the prior year, higher warranty expense and unfavorable currency impact offset in part by the benefit of the GAS acquisition. Refer to note 19 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K, for further details of segment revenue and operating profit. LIQUIDITY AND CAPITAL RESOURCES Capital resources are obtained from income retained in the business, borrowings under the Company's senior notes, committed and uncommitted credit facilities, long-term industrial revenue bonds and operating and capital leasing arrangements. Management expects that the Company's capital resources will be sufficient to finance planned working capital needs, research and development activities, investments in facilities or equipment, pension contributions, the payment of dividends on the Company's common shares and any repurchases of the Company's common shares for at least the next 12 months. At December 31, 2013, $468,109 or 98.8 percent of the Company's cash and cash equivalents and short-term investments reside in international tax jurisdictions. Repatriation of these funds could be negatively impacted by potential payments for foreign and domestic taxes, excluding $15,986 that is available for repatriation with no additional tax expense because the Company has already provided for such taxes. Part of the Company's growth strategy is to pursue strategic acquisitions. The Company has made acquisitions in the past and intends to make acquisitions in the future. The Company intends to finance any future acquisitions with either cash and short-term investments, 33-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) cash provided from operations, borrowings under available credit facilities, proceeds from debt or equity offerings and/or the issuance of common shares. The Company's global liquidity as of December 31, 2013 and 2012 was as follows: 2013 2012 Cash and cash equivalents $ 230,709 $ 368,792 Additional cash availability from: Short-term uncommitted lines of credit 63,747 77,421 Five-year credit facility 261,000 200,000 Short-term investments 242,988 261,886 Total global liquidity $ 798,444 $ 908,099 The following table summarizes the results of our consolidated statement of cash flows for the years ended December 31: Net cash flow provided by (used in): 2013 2012 2011 Operating activities $ 124,224 $ 135,508 $ 215,397 Investing activities (52,719 ) (72,831 ) (90,706 ) Financing activities (204,449 ) (36,227 ) (123,535 ) Effect of exchange rate changes on cash and cash equivalents (5,139 ) 8,422 4,106 Net (decrease) increase in cash and cash equivalents $ (138,083 ) $ 34,872 $ 5,262 During 2013, the Company generated $124,224 in cash from operating activities, a decrease of $11,284 from 2012. Cash flows from operating activities are generated primarily from operating income and managing the components of working capital. Cash flows from operating activities during the year ended December 31, 2013 compared to the year ended December 31, 2012 were negatively impacted by a $256,067 unfavorable change in net (loss) income, as well as unfavorable changes in prepaid income taxes, accounts payable, deferred income taxes and certain other assets and liabilities. These changes were partially offset by favorable changes in trade receivables, prepaid expenses, other current assets, deferred revenue and pension and post-retirement benefits. Net cash used in investing activities was $52,719 in 2013, an improvement of $20,112 from 2012. The improvement was primarily due to a $14,295 reduction in capital expenditures, $28,292 paid for acquisitions in 2012 and a $4,179 increase in proceeds from sale of assets. These activities were partially offset by a $16,128 change in net investment security activity and a $9,856 reduction in collections on purchased finance receivables. Net cash used in financing activities was $204,449 in 2013, an increase of $168,222 from 2012. The increase was primarily due to $126,670 of net debt repayments in 2013 compared to $23,625 of net debt borrowings in the prior year and an increase of $14,821 in distributions to noncontrolling interest holders. Benefit Plans The Company expects to contribute $4,567 to its pension plans during the year ending December 31, 2014. Beyond 2014, minimum statutory funding requirements for the Company's U.S. pension plans may become significant. The actual amounts required to be contributed are dependent upon, among other things, interest rates, underlying asset returns and the impact of legislative or regulatory actions related to pension funding obligations. The Company has adopted a pension investment policy designed to achieve an adequate funded status based on expected benefit payouts and to establish an asset allocation that will meet or exceed the return assumption while maintaining a prudent level of risk. The plan's target asset allocation adjusts based on the plan's funded status. As the funded status improves or declines, the debt security target allocation will increase and decrease, respectively. Payments due under the Company's other post-retirement benefit plans are not required to be funded in advance. Payments are made as medical costs are incurred by covered retirees, and are principally dependent upon the future cost of retiree medical benefits under these plans. The Company expects the other post-retirement benefit plan payments to approximate $1,695 in 2014. Refer to note 12 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K, for further discussion of the Company's pension and other post-retirement benefit plans. 34-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Dividends The Company paid dividends of $73,997, $72,830 and $72,901 in the years ended December 31, 2013, 2012 and 2011, respectively. Annualized dividends per share were $1.15, $1.14 and $1.12 for the years ended December 31, 2013, 2012 and 2011, respectively. The quarterly 2014 cash dividend represents $1.15 per share on an annualized basis. Contractual Obligations The following table summarizes the Company's approximate obligations and commitments to make future payments under contractual obligations as of December 31, 2013: Payment due by period Less than 1 More than 5 Total year 1-3 years 3-5 years years Minimum operating lease obligations $ 112,586 $ 36,216 $ 43,550 $ 16,676 $ 16,144 Debt 524,033 43,791 416,666 63,576 - Interest on debt (1) 45,212 16,232 24,700 4,280 - Purchase commitments 17,355 17,355 - - - Total $ 699,186 $ 113,594 $ 484,916 $ 84,532 $ 16,144 (1) Amounts represent estimated contractual interest payments on outstanding long-term debt and notes payable. Rates in effect as of December 31, 2013 are used for variable rate debt. At December 31, 2013, the Company also maintained uncertain tax positions of $16,545, for which there is a high degree of uncertainty as to the expected timing of payments (refer to note 4 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K). As of December 31, 2013, the Company had various short-term uncommitted lines of credit with borrowing limits of $106,809. The weighted-average interest rate on outstanding borrowings on the short-term uncommitted lines of credit as of December 31, 2013 and 2012 was 3.24 percent and 2.81 percent, respectively. The increase in the weighted-average interest rate is attributable to the change in mix of borrowings in foreign entities. Short-term uncommitted lines mature in less than one year. The amount available under the short-term uncommitted lines at December 31, 2013 was $63,747. As of December 31, 2013, the Company had borrowing limits under its credit facility totaling $500,000, which expires in June 2016. Under the terms of the credit facility agreement, the Company has the ability, subject to various approvals, to increase the borrowing limits by $250,000. Up to $50,000 of the revolving credit facility is available under a swing line subfacility. The weighted-average interest rate on outstanding credit facility borrowings as of December 31, 2013 and 2012 was 1.36 percent and 1.33 percent, respectively, which is variable based on the London Interbank Offered Rate (LIBOR). The amount available under the credit facility as of December 31, 2013 was $261,000. The Company incurred $1,876 of fees related to its credit facility in 2011, which are amortized as a component of interest expense over the term of the facility. In March 2006, the Company issued senior notes in an aggregate principal amount of $300,000 with a weighted-average fixed interest rate of 5.50 percent. The Company entered into a derivative transaction to hedge interest rate risk on $200,000 of the senior notes, which was treated as a cash flow hedge. This reduced the effective interest rate from 5.50 percent to 5.36 percent. The Company funded the repayment of $75,000 of the senior notes at maturity in March 2013 using borrowings under its revolving credit facility. The maturity dates of the remaining senior notes are staggered, with $175,000 and $50,000 due in 2016 and 2018, respectively. The Company's financing agreements contain various restrictive financial covenants, including net debt to capitalization and net interest coverage ratios. As of December 31, 2013, the Company was in compliance with the financial covenants in its debt agreements. Off-Balance Sheet Arrangements The Company enters into various arrangements not recognized in the consolidated balance sheets that have or could have an effect on its financial condition, results of operations, liquidity, capital expenditures or capital resources. The principal off-balance sheet arrangements that the Company enters into are guarantees, operating leases (refer to note 13 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K) and sales of finance receivables. The Company provides its global operations guarantees and standby letters of credit through various financial institutions to suppliers, regulatory agencies and insurance providers. If the Company is not able to make payment, the suppliers, regulatory agencies and insurance providers may draw on the pertinent bank. Refer to note 14 to the consolidated financial 35-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) statements, which is contained in Item 8 of this annual report on Form 10-K, for further details of guarantees. The Company has sold finance receivables to financial institutions while continuing to service the receivables. The Company records these sales by removing finance receivables from the consolidated balance sheets and recording gains and losses in the consolidated statement of operations. Refer to note 6 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K, for further details on finance lease receivables. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements. The consolidated financial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP). The preparation of the accompanying consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities and reported amounts of revenues and expenses. Such estimates include revenue recognition, the valuation of trade and financing receivables, inventories, goodwill, intangible assets, other long-lived assets, legal contingencies, guarantee obligations, and assumptions used in the calculation of income taxes, pension and post-retirement benefits and customer incentives, among others. These estimates and assumptions are based on management's best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors. Management monitors the economic conditions and other factors and will adjust such estimates and assumptions when facts and circumstances dictate. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. The Company's significant accounting policies are described in note 1 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K. Management believes that, of its significant accounting policies, its policies concerning revenue recognition, allowances for credit losses, inventory reserves, goodwill, taxes on income and pensions and post-retirement benefits are the most critical because they are affected significantly by judgments, assumptions and estimates. Additional information regarding these policies is included below. Revenue Recognition The Company records revenue when it is realized, or realizable and earned. The application of U.S. GAAP revenue recognition principles to the Company's customer contracts requires judgment, including the determination of whether an arrangement includes multiple deliverables such as hardware, software, maintenance and /or other services. For contracts that contain multiple deliverables, total arrangement consideration is allocated at the inception of the arrangement to each deliverable based on the relative selling price method. The relative selling price method is based on a hierarchy consisting of vendor specific objective evidence (VSOE) (price sold on a stand-alone basis), if available, or third-party evidence (TPE), if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. The Company's ESP is consistent with the objective of determining VSOE, which is the price at which we would expect to transact on a stand-alone sale of the deliverable. The determination of ESP is based on applying significant judgment to weigh a variety of company-specific factors including our pricing practices, customer volume, geography, internal costs and gross margin objectives. This information is gathered from experience in customer negotiations, recent technological trends and the competitive landscape. In contracts that involve multiple deliverables, maintenance services are typically accounted for under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 605-20, Separately Priced Extended Warranty and Product Maintenance Contracts. There have been no material changes to these estimates for the periods presented and the Company believes that these estimates generally should not be subject to significant changes in the future. However, changes to deliverables in future arrangements could materially impact the amount of earned or deferred revenue. For sales of software, excluding software required for the equipment to operate as intended, the Company applies the software revenue recognition principles within FASB ASC 985-605, Software - Revenue Recognition. For software and software-related deliverables (software elements), the Company allocates revenue based upon the relative fair value of these deliverables as determined by VSOE. If the Company cannot obtain VSOE for any undelivered software element, revenue is deferred until all deliverables have been delivered or until VSOE can be determined for any remaining undelivered software elements. When the fair value of a delivered element cannot be established, but fair value evidence exists for the undelivered software elements, the Company uses the residual method to recognize revenue. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement consideration is allocated to the delivered elements and recognized as revenue. Determination of amounts deferred for software support requires judgment about whether the deliverables can be divided into more than one unit of accounting and whether the separate deliverables have value to the customer on a stand-alone basis. 36-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) There have been no material changes to these deliverables for the periods presented. However, changes to deliverables in future arrangements and the ability to establish VSOE could affect the amount and timing of revenue recognition. Allowances for Credit Losses The Company maintains allowances for potential credit losses and such losses have been minimal and within management's expectations. Since the Company's receivable balance is concentrated primarily in the financial and government sectors, an economic downturn in these sectors could result in higher than expected credit losses. The concentration of credit risk in the Company's trade receivables with respect to financial and government customers is largely mitigated by the Company's credit evaluation process and the geographical dispersion of sales transactions from a large number of individual customers. Inventory Reserves At each reporting period, the Company identifies and writes down its excess and obsolete inventories to net realizable value based on usage forecasts, order volume and inventory aging. With the development of new products, the Company also rationalizes its product offerings and will write-down discontinued product to the lower of cost or net realizable value. Goodwill Goodwill is the cost in excess of the net assets of acquired businesses (refer to note 10 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K). The Company tests all existing goodwill at least annually as of November 30 for impairment on a reporting unit basis. The Company tests for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the carrying value of a reporting unit below its reported amount. The Company's five reporting units are defined as Domestic and Canada, Brazil, LA, AP and EMEA. Each year, the Company may elect to perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. In evaluating whether it is more likely than not the fair value of a reporting unit is less than its carrying amount, the Company considers the following events and circumstances, among others, if applicable: (a) macroeconomic conditions such as general economic conditions, limitations on accessing capital or other developments in equity and credit markets; (b) industry and market considerations such as competition, multiples or metrics and changes in the market for the Company's products and services or regulatory and political environments; (c) cost factors such as raw materials, labor or other costs; (d) overall financial performance such as cash flows, actual and planned revenue and earnings compared with actual and projected results of relevant prior periods; (e) other relevant events such as changes in key personnel, strategy or customers; (f) changes in the composition of a reporting unit's assets or expected sales of all or a portion of a reporting unit; and (g) any sustained decrease in share price. If the Company's qualitative assessment indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying value, or if management elects to perform a quantitative assessment of goodwill, a two-step impairment test is used to identify potential goodwill impairment and measure the amount of any impairment loss to be recognized. In the first step, the Company compares the fair value of each reporting unit with its carrying value. The fair value is determined based upon discounted estimated future cash flows as well as the market approach or guideline public company method. The Company's Step 1 impairment test of goodwill of a reporting unit is based upon the fair value of the reporting unit, defined as the price that would be received to sell the net assets or transfer the net liabilities in an orderly transaction between market participants at the assessment date. In the event that the net carrying amount exceeds the fair value, a Step 2 test must be performed whereby the fair value of the reporting unit's goodwill must be estimated to determine if it is less than its net carrying amount. In its two-step test, the Company uses the discounted cash flow method and the guideline company method for determining the fair value of its reporting units. Under these methods, the determination of implied fair value of the goodwill for a particular reporting unit is the excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities in the same manner as the allocation in a business combination. The techniques used in the Company's qualitative assessment and, if necessary, two-step impairment test have incorporated a number of assumptions that the Company believes to be reasonable and to reflect market conditions forecast at the assessment date. Assumptions in estimating future cash flows are subject to a high degree of judgment. The Company makes all efforts to forecast future cash flows as accurately as possible with the information available at the time the forecast is made. To this end, the Company evaluates the appropriateness of its assumptions as well as its overall forecasts by comparing projected results of upcoming years with actual results of preceding years and validating that differences therein are reasonable. Key assumptions, all of which are Level 3 inputs (refer to note 18 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K), relate to price trends, material costs, discount rate, customer demand, and the long-term growth and foreign exchange rates. A number of benchmarks from independent industry and other economic publications were also used. Changes in assumptions and estimates after the assessment date may lead to an outcome where impairment charges would be required in future periods. Specifically, actual results may vary from the Company's forecasts and such variations may be material and 37-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) unfavorable, thereby triggering the need for future impairment tests where the conclusions may differ in reflection of prevailing market conditions. During the third quarter of 2013, the Company performed an other-than-annual assessment for its Brazil reporting unit based on a two-step impairment test as a result of a reduced earnings outlook for the Brazil business unit. This was due to a deteriorating macro-economic outlook, structural changes to an auction-based purchasing environment and new competitors entering the market. The Company concluded that the goodwill within the Brazil reporting unit was partially impaired and recorded a $70,000 pre-tax, non-cash goodwill impairment charge. In the fourth quarter of 2013, the Brazil reporting unit was reviewed for impairment based on a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. In addition, the remaining reporting units were reviewed based on a two-step test. These tests resulted in no additional impairment in any of the Company's reporting units. The Company concluded the AP reporting unit had excess fair value of approximately $23,000 or eight percent when compared to its carrying amount. The Domestic and Canada and LA reporting units had excess fair value greater than 100 percent when compared to their carrying amounts. In 2012, goodwill was reviewed for impairment based on a two-step test which resulted in no impairment in any of the Company's reporting units. In 2011, the Company performed a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. In the 2011 qualitative assessment, management concluded that the Company's reporting units were not at risk of failing step one and, therefore, the two-step impairment test was not performed. Long-Lived Assets Impairment of long-lived assets is recognized when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the expected future undiscounted cash flows are less than the carrying amount of the asset, an impairment loss is recognized at that time to reduce the asset to the lower of its fair value or its net book value. Taxes on Income Deferred taxes are provided on an asset and liability method, whereby deferred tax assets are recognized for deductible temporary differences, operating loss carry-forwards and tax credits. Deferred tax liabilities are recognized for taxable temporary differences and undistributed earnings in certain jurisdictions. Deferred tax assets are reduced by a valuation allowance when, based upon the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Determination of a valuation allowance involves estimates regarding the timing and amount of the reversal of taxable temporary differences, expected future taxable income and the impact of tax planning strategies. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company operates in numerous taxing jurisdictions and is subject to examination by various federal, state and foreign jurisdictions for various tax periods. Additionally, the Company has retained tax liabilities and the rights to tax refunds in connection with various acquisitions and divestitures of businesses. The Company's income tax positions are based on research and interpretations of the income tax laws and rulings in each of the jurisdictions in which the Company does business. Due to the subjectivity of interpretations of laws and rulings in each jurisdiction, the differences and interplay in tax laws between those jurisdictions, as well as the inherent uncertainty in estimating the final resolution of complex tax audit matters, the Company's estimates of income tax liabilities may differ from actual payments or assessments. The Company assesses its position with regard to tax exposures and records liabilities for these uncertain tax positions and any related interest and penalties, when the tax benefit is not more likely than not realizable. The Company has recorded an accrual that reflects the recognition and measurement process for the financial statement recognition and measurement of a tax position taken or expected to be taken on a tax return. Additional future income tax expense or benefit may be recognized once the positions are effectively settled. At the end of each interim reporting period, the Company estimates the effective tax rate expected to apply to the full fiscal year. The estimated effective tax rate contemplates the expected jurisdiction where income is earned, as well as tax planning alternatives. Current and projected growth in income in higher tax jurisdictions may result in an increasing effective tax rate over time. If the actual results differ from estimates, the Company may adjust the effective tax rate in the interim period if such determination is made. 38-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) Contingencies Liabilities for loss contingencies arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred. There is no liability recorded for matters in which the liability is not probable and reasonably estimable. Attorneys in the Company's legal department monitor and manage all claims filed against the Company and review all pending investigations. Generally, the estimate of probable loss related to these matters is developed in consultation with internal and outside legal counsel representing the Company. These estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The Company attempts to resolve these matters through settlements, mediation and arbitration proceedings when possible. If the actual settlement costs, final judgments, or fines, after appeals, differ from the estimates, the future results may be materially impacted. Adjustments to the initial estimates are recorded when a change in the estimate is identified. Pensions and Other Post-retirement Benefits Annual net periodic expense and benefit liabilities under the Company's defined benefit plans are determined on an actuarial basis. Assumptions used in the actuarial calculations have a significant impact on plan obligations and expense. Members of the management investment committee periodically review the actual experience compared with the more significant assumptions used and make adjustments to the assumptions, if warranted. The discount rate is determined by analyzing the average return of high-quality (i.e., AA-rated) fixed-income investments and the year-over-year comparison of certain widely used benchmark indices as of the measurement date. The expected long-term rate of return on plan assets is determined using the plans' current asset allocation and their expected rates of return based on a geometric averaging over 20 years. The rate of compensation increase assumptions reflects the Company's long-term actual experience and future and near-term outlook. Pension benefits are funded through deposits with trustees. Other post-retirement benefits are not funded and the Company's policy is to pay these benefits as they become due. The following table represents assumed healthcare cost trend rates at December 31: 2013 2012 Healthcare cost trend rate assumed for next year 7.5 % 8.0 % Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) 5.0 % 4.2 % Year that rate reaches ultimate trend rate 2019 2099 The healthcare trend rates are reviewed based upon the results of actual claims experience. The Company used healthcare cost trends of 7.5 percent and 8.0 percent in 2014 and 2013, respectively, decreasing to an ultimate trend of 5.0 percent in 2019 for both medical and prescription drug benefits using the Society of Actuaries Long Term Trend Model with assumptions based on the 2008 Medicare Trustees' projections. Assumed healthcare cost trend rates have a significant effect on the amounts reported for the healthcare plans. A one-percentage-point change in assumed healthcare cost trend rates would have the following effects: One-Percentage-Point One-Percentage-Point Increase Decrease Effect on total of service and interest cost $ 38 $ (35 ) Effect on other post-retirement benefit obligation $ 678 $ (624 ) RECENTLY ISSUED ACCOUNTING GUIDANCE Refer to note 1 to the consolidated financial statements, which is contained in Item 8 of this annual report on Form 10-K, for information on recently issued accounting guidance. 39-------------------------------------------------------------------------------- Table of Contents MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS as of December 31, 2013 DIEBOLD, INCORPORATED AND SUBSIDIARIES (unaudited) (dollars in thousands, except per share amounts) FORWARD-LOOKING STATEMENT DISCLOSURE In this annual report on Form 10-K, statements that are not reported financial results or other historical information are "forward-looking statements." Forward-looking statements give current expectations or forecasts of future events and are not guarantees of future performance. These forward-looking statements relate to, among other things, the Company's future operating performance, the Company's share of new and existing markets, the Company's short- and long-term revenue and earnings growth rates, the Company's implementation of cost-reduction initiatives and measures to improve pricing, including the optimization of the Company's manufacturing capacity. The use of the words "will," "believes," "anticipates," "plans," "projects," "expects," "intends" and similar expressions is intended to identify forward-looking statements that have been made and may in the future be made by or on behalf of the Company. Although the Company believes that these forward-looking statements are based upon reasonable assumptions regarding, among other things, the economy, its knowledge of its business, and on key performance indicators that impact the Company, these forward-looking statements involve risks, uncertainties and other factors that may cause actual results to differ materially from those expressed in or implied by the forward-looking statements. The Company is not obligated to update forward-looking statements, whether as a result of new information, future events or otherwise. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Some of the risks, uncertainties and other factors that could cause actual results to differ materially from those expressed in or implied by the forward-looking statements include, but are not limited to: • competitive pressures, including pricing pressures and technological developments; • changes in the Company's relationships with customers, suppliers, distributors and/or partners in its business ventures; • changes in political, economic or other factors such as currency exchange rates, inflation rates, recessionary or expansive trends, taxes and regulations and laws affecting the worldwide business in each of the Company's operations, including Brazil, where a significant portion of the Company's revenue is derived; • global economic conditions, including any additional deterioration and disruptions in the financial markets, including bankruptcies, restructurings or consolidations of financial institutions, which could reduce our customer base and/or adversely affect our customers' ability to make capital expenditures, as well as adversely impact the availability and cost of credit; • acceptance of the Company's product and technology introductions in the marketplace; • the Company's ability to maintain effective internal controls; • changes in the Company's intention to further repatriate cash and cash equivalents and short-term investments residing in international tax jurisdictions could negatively impact foreign and domestic taxes; • unanticipated litigation, claims or assessments, as well as the outcome/impact of any current/pending litigation, claims or assessments, including with respect to the Company's Brazilian tax dispute; • variations in consumer demand for financial self-service technologies, products and services; • potential security violations to the Company's information technology systems; • the investment performance of the Company's pension plan assets, which could require the Company to increase its pension contributions, and significant changes in healthcare costs, including those that may result from government action; • the amount and timing of repurchases of the Company's common shares, if any; • the outcome of the Company's assessment of its indirect tax compliance in Brazil; • the Company's ability to successfully implement its multi-year turnaround strategy, Diebold 2.0; • the Company's ability to achieve benefits from its cost-reduction initiatives and other strategic changes, including its multi-year realignment plan and other restructuring actions; and • the risk factors described above under Item 1A "Risk Factors." 40-------------------------------------------------------------------------------- |