DECEMBER 2002

Examining The Management Discussion And Analysis (MD&A) Section

Diebold 1998 Annual Report

Financial reports are required by law and are published both quarterly and annually. The annual report will always include a fairly comprehensive Management Discussion and Analysis (MD&A). This is highly recommended reading during the study of any company. The management discussion give investors a better understanding of what the company does and usually points out some key areas where they did well.

The statements indicated in bolded text found in the Management Discussion & Analysis identifies topics which will be covered in the workshop.

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Realignment and Special Charges

In the second quarter of 1998, the Company recorded realignment and special charges of $61,117 ($41,850 after-tax or $0.60 per diluted share). The majority of the realignment charge related to three areas: the ending of the InterBold joint venture with IBM, the exiting of the manufacturing and distribution channel for certain low-end self-service terminal products, and the exiting of the proprietary electronic security business. The realignment charge was made up of two components: a special charge of $9,864 for the write-off of primarily inventory from exited lines of business and a realignment charge of $51,253 for all other realignment costs.

Industry-wide banking trends such as bank mega-mergers, as well as the transition from IBM to the Company's own international distribution channels, prompted the re-evaluation of the Company's business plans and organizational structure. North American facilities were consolidated and certain facilities were closed. More than 600 jobs were estimated to be eliminated. At December 31, 1998, 519 jobs had been terminated. The Company estimated savings of $22,000 annually from the realignment program. Details of the components and remaining realignment accrual can be found in Note 8 to the 1998 Consolidated Financial Statements.

Operating Segments

The Company adopted Statement of Financial Accounting Standards No. 131, "Operating Segments," for the 1998 Annual Report. The Company reports the following operating segments: North American Sales and Service, International Sales and Service, Manufacturing and Development, and Corporate.

North American Sales and Service operating profit in 1998, 1997 and 1996 was $149,231, $164,723 and $147,589, respectively. The decline in profit from 1997 to 1998 was due mainly to decreased shipments of ATMs. Operating profit for the International Sales and Service organization in 1998, 1997 and 1996 was $8,189, $18,170 and $7,936, respectively. The decline in 1998 operating profit internationally is attributed to expenses relating to the Company setting up its own international distribution systems. Details of revenue from customers, inter-segment revenues and operating profit contribution can be found in Note 16 to the 1998 Consolidated Financial Statements.

Net Sales

Net sales for 1998 totaled $1,185,707, which represented a decline of $41,229 or 3.4 percent from 1997 and growth of $155,516 or 15.1 percent from 1996. In 1998, sales exceeded the $1 billion mark for the third consecutive year in the Company's 139-year history.

Product net sales of $750,161 fell short of 1997 by $74,964 or 9.1 percent, while product net sales were up over 1996 by $71,108 or 10.5 percent. During 1998, the Company experienced a slowdown in global sales of ATMs. The decrease in sales volumes can be attributed to recent banking industry mega-mergers as well as banks channeling resources into remediating year 2000 issues, as opposed to making capital expenditures for ATMs. Sales to IBM dropped by 14.4 percent in 1998 versus 1997, when IBM was the Company's main international distribution channel. The Company is currently implementing plans for its own international sales and distribution channels. Total U.S. product revenue in 1998 fell 9.8 percent from 1997, and sales of products outside the United States fell 7.6 percent in 1998 from 1997.

1998 was a strong year for the Company's service business. Service net sales of $435,546 increased $33,735 or 8.4 percent from 1997 and were up $84,408 or 24.0 percent from 1996. The major factors contributing to the service revenue gain in 1998 were the growth of the installed base of equipment resulting from new product installations and continued growth of service offerings such as first-line maintenance.

Total product backlog of unfilled orders reached $299,739 at December 31, 1998, compared with $276,986 at the end of 1997 and $233,586 at the end of 1996. The December 31, 1998 backlog is the highest level attained in the Company's history. While this increase in backlog is considered favorable, backlog is not the sole indicator of future revenue streams. Production schedules, customer priorities and other such factors can affect the pace of converting backlog into revenue.

Cost of Sales and Expenses

Cost of sales for 1998 was $779,457, compared with $796,836 in 1997 and $672,679 in 1996. The 1998 decline is mostly attributable to lower sales volumes on ATMs.

Gross profits on product sales decreased $30,430 from 1997 and increased $29,581 from 1996 to a level of $287,373 in 1998. Product gross margins in 1998 were 38.3 percent of product sales, compared with 38.5 percent in 1997 and 38.0 percent in 1996. The relative stability of product gross profits as a percentage of product sales is due to the Company's continued cost-reduction efforts.

Service gross profits of $128,741 in 1998 increased from $112,297 in 1997 and $99,720 in 1996. Service gross margins as a percentage of service sales were 29.6 percent in 1998, 27.9 percent in 1997, and 28.4 percent in 1996. Gross margins on service sales improved in 1998 over previous years due mainly to increased profitability in North America.

Operating expenses in 1998 were $248,750 (excluding realignment charges) compared with $246,239 in 1997 and $217,148 in 1996. The stability of operating expenses in 1998 stems from the Company's efforts to contain operating costs on lower sales volumes. Operating expenses as a percentage of net sales were 21.0 percent in 1998 (excluding realignment charges), 20.1 percent in 1997 and 21.1 percent in 1996.

Operating profit of $167,364 in 1998 (excluding realignment charges) decreased 9.0 percent from $183,861 in 1997, and increased 19.2 percent over 1996 operating profits of $140,364. Operating profit margin of 14.1 percent in 1998 (excluding realignment charges) fell slightly over 1997 operating profit margin of 15.0 percent, but grew over the 13.6 percent margin in 1996.

Other Income, Net and Minority Interest

Other income, net increased $8,509 from 1997 and $4,870 from 1996. The net increase is due in part to reduced amortization costs relating to intangible assets. Investment income decreased in 1998 as compared with 1997 due to lower interest rates achieved in the Company's municipal bond portfolio. The drop in municipal bond interest was partially offset by a continued growth in interest income from finance receivables.

Minority interest of $1,843 decreased from $5,096 in 1997 and $4,393 in 1996 due to the Company purchasing IBM's 30 percent minority share in the InterBold joint venture in January 1998. Minority interest consisted primarily of income or losses allocated to the minority ownership of Diebold Financial Equipment Company, Ltd. (China) and Diebold OLTP Systems C.A. (Venezuela). Minority interests for all companies are calculated as a percentage of profits of the joint ventures based on formulas defined in the relevant agreements establishing each venture.

Income

1998 income before taxes amounted to $180,924 (excluding realignment charges). Although 1998 income before taxes decreased from 1997 results of $185,659, 1998 income before taxes as a percentage of net sales was 15.3 percent, an improvement over 1997's 15.1 percent of net sales. 1996 income before taxes was $146,504, or 14.2 percent of net sales.

The effective tax rate was 36.4 percent in 1998 compared with 34.0 percent in 1997 and 33.5 percent in 1996. The primary reason for the higher tax rate in 1998 was the write-off of intangible assets in connection with the Company's realignment program, which are non-deductible for tax purposes. The Company expects the effective tax rate to trend higher in the future due to a reduction in tax-exempt interest as a percentage of pretax income and tax law changes that have affected insurance contracts. Details of the reconciliation between the U.S. statutory rate and the effective tax rate are included in Note 14 of the 1998 Consolidated Financial Statements.

1998 net income of $117,998 (excluding realignment charges) fell short of 1997 results of $122,516. F or both 1998 (excluding realignment charges) and 1997, net income as a percentage of net sales was 10.0 percent.Net income in 1996 was $97,425, or 9.5 percent of net sales.

Management's Analysis of Financial Condition

The Company continued to enhance its financial position during 1998. Total assets increased $13,138 or 1.3 percent to a 1998 year-end level of $1,004,188. Asset turn-over (excluding cash, cash equivalents and short-term and long-term investment securities) fell in 1998 to 1.53 versus 1.69 in 1997.

Total current assets at December 31, 1998, of $543,548 represented a decrease of $6,289 or 1.1 percent from the prior year-end. The decrease in trade receivables and inventories was offset by an increase in cash, finance receivables and deferred income taxes. Trade receivables decreased $35,994 or 11.9 percent to a level of $266,891 at December 31, 1998. As a percentage of net sales, trade receivables were 22.5 percent in 1998, 24.7 percent in 1997 and 24.9 percent in 1996. Inventories at year-end 1998 totaled $127,880, which represented a decrease of $202 or 0.2 percent from 1997. The decrease in trade receivables and inventory was due to decreased sales volumes as well as the write-off of certain accounts receivable and inventory under the Company's realignment program.

Short-term investments and long-term securities and other investments increased by $31,106 or 17.8 percent to a level of $205,441 at December 31, 1998, largely due to additional cash flow from operating activities. The Company anticipates being able to meet both short- and long-term operational funding requirements without liquidating individual securities prior to maturity by varying the timing of maturities within the portfolio. However, since most of these securities are marketable, they could readily be converted into cash and cash equivalents if needed to fund future acquisitions, joint ventures and strategic alliances throughout the world as part of a continuing strategy to strengthen the Company's global competitiveness.

Total property, plant and equipment, net of accumulated depreciation, was $147,131 at the end of 1998, which represented a net increase of $3,230 or 2.2 percent over prior year-end. Capital expenditures were $30,768 in 1998, compared with $67,722 in 1997. The drop in 1998 capital spending versus 1997 was expected in light of the high level of capital expenditures in 1997 from the expansion of facilities for manufacturing, research, software development, management development and support services. The accounting for the Company's investment in projects related to internal applications hardware and software has been done in accordance with EITF Issue 97-13, "Accounting for Business Process Reengineering Costs." Accordingly, the Company has expensed as incurred, when applicable, business process re-engineering costs as well as expenditures incurred for preliminary software project stage activities. The Company has capitalized costs related to application development stage activities, post-implementation/operation stage activities, as well as fixed asset acquisitions, such as new computer equipment, office furniture and work stations related to these projects.

Total current liabilities at December 31, 1998, were $235,533, which represented a decrease of $6,547 or 2.7 percent from the prior year-end. The primary cause for the decrease in current liabilities was due to a 13.6 percent drop in accounts payable. The Company's current ratio was 2.3 at the end of 1998 as well as 1997.

At December 31, 1998, the Company had lines of credit totaling $150,000, all unrestricted as to use. In addition, the Company had outstanding $20,800 of Industrial Development Revenue Bonds. The proceeds of the bonds issued in 1997 were used to finance three manufacturing facilities located in Staunton and Danville, Virginia, and in Lexington, North Carolina.

The Company's financial position provides it with sufficient resources to meet projected future capital expenditures, dividend and working capital requirements. However, if the need arises, the Company's strong financial position should ensure the availability of adequate additional financial resources.

Pension liabilities were $22,745 at December 31, 1998, representing an increase of $2,130 or 10.3 percent over prior year-end. The net periodic pension costs of $4,864 charged to income in 1998 represented an increase of $218 from the prior year.

Minority interests of $3,741 represented the minority interest in Diebold Financial Equipment Company, Ltd. (China), owned by the Aircraft Industries of China and the Industrial and Commercial Bank of China, Shanghai Pudong Branch and the minority interest in Diebold OLTP Systems, C.A (Venezuela), owned by five individual investors. Shareholders' equity increased $30,542 or 4.6 percent to $699,123 at December 31, 1998. Shareholders' equity per share was $10.15 at the end of 1998, compared with $9.69 in 1997. The Common Shares of the Company are listed on the New York Stock Exchange with a symbol of DBD. There were approximately 7,782 registered shareholders of record as of December 31, 1998.

The Board of Directors declared a first-quarter 1999 cash dividend of $0.15 per share. This amount, which represents a 7.1 percent increase from the prior year's quarterly dividend rate, will be paid on March 12, 1999, to shareholders of record on February 19, 1999. Comparative quarterly cash dividends paid in 1998 and 1997 were $0.14 and $0.125 per share, respectively.

Management's Analysis of Cash Flows

During 1998, the Company generated $177,238 in cash from operating activities, compared with $111,330 in 1997 and $96,456 in 1996. In addition to net income of $76,148 adjusted for depreciation, amortization and other charges of $39,540, decreases in accounts receivable also increased cash provided by operations. Cash was utilized in operations to reduce accounts payable and to maintain adequate inventory levels. Expressed as a percentage of total assets employed, the Company's cash yield from operations was 17.6 percent in 1998, and 11.2 percent in 1997 and 1996.

Net cash generated from operating activities in 1998 was used to reinvest $96,509 inassets of the Company, compared with $102,725 in 1997 and $55,299 in 1996. The Company returned $38,631 to shareholders in the form of cash dividends paid during 1998, which was a 12.1 percent increase from 1997 and a 23.9 percent increase from 1996.

Return to Financial Statements Workshop

Diane Graese was formerly an officer of the Computer Group Advisory Board and a director for the BetterInvesting Las Vegas Chapter. She is an active member of i-club-list and the BetterIinvesting Community at Compuserve. Diane is well known for her seminars on cash flow and interpreting financial statements. Contact Diane at dmg1031@aol.com.