Diebold Nixdorf, Incorporated (DBD) Earnings Call Transcript & Summary

Hello, and welcome to the JPMorgan TMC Conference. My name is Paul Chung, and I cover highly emerging tech here at the firm. We are happy to have Diebold's CEO, Gerrard Schmid, here for this session today. [Operator Instructions] So Gerrard, welcome, and thank you for your time today. Can we just start by providing a brief overview of the firm?

Sure, Paul. And first off, thank you for hosting us. It's a pleasure being here. So I've been CEO of Diebold Nixdorf since 2018. And for those of you that know us less well, we're a critical supplier of connected commerce solutions to banks and retailers around the world. Today, we generate roughly $4 billion of revenue with 73% from Banking, 27% from Retail, with roughly 63% of our revenues coming from services and software. Today, we're a market leader globally in ATMs, with roughly 1/3 of all ATMs on the planet coming from Diebold Nixdorf. And in Europe, we're a leader in point-of-sale and self-checkout technologies, where we deliver automation to retailers, in particular, Tier 1 retailers.

Got you. Thanks for that quick overview. And then let's just dig in. So since you became CEO in 2018, what are some of the key things you've learned with respect to the industry and DN Now transformation and all that good stuff?

Yes. Thanks, Paul. This is now the third year of our DN Now transformation program. And we sought to put the program in place to fundamentally transform the operating model of the business that historically was very dependent on hardware, and to a lesser extent, services and software. Now we're into the third year of the program, and we've just had superb momentum over that time frame. In the first year, we realized $175 million of gross savings; in the second year, $165 million; and this year, we're well on track to deliver another $160 million of value. And what we've done is we've looked at all aspects of the company through the lens of our operations and through the lens of our customers. We've modernized our services stack. We've driven a software operational excellence program. We've reduced G&A. And the net impact has been great momentum. We've managed to increase our adjusted EBITDA margins by about 600 basis points since 2018, with our EBITDA margins growing from 7% to just under 12%. And equally importantly, our return on invested capital has grown from low single-digit numbers in 2018 to 15% last year, and this year, we're tracking towards around about 18%. So all in all, very, very pleased with the momentum that we're seeing in the company today. I think as the world starts to emerge from the pandemic, we feel we're competitively very well positioned to take advantage of some of the tailwinds from increased demand from customers, but also very well positioned in our product suite relative to others.

Got you. So during the pandemic, self-checkout became a big priority for a lot of your customers. So let's just start there. Where do you see this business trend as we kind of move out through the year and beyond?

Yes, Paul, I'd say that the momentum for self-checkout began pre-pandemic, and what it simply done is it's accelerated the momentum there. We started off 2021 with great strength, including several competitive takeaways. And we see that momentum continuing well through 2021 and well beyond. There's a very strong business case for retailers. It's tougher to find labor these days, and self-checkout gives them meaningful labor savings and deploying self-checkout. But equally importantly, the consumers are demanding less engagement with tellers and more self-checkout answers. We continue to see growth not only in our core European market but we also added some new recent wins in the United States. And for 2021, we expect our growth rates to be in the strong double digits. Although quite frankly, we'd be hard pressed to beat our shipment growth rate last year, where shipments grew more than 90%. But this year, we will have a really strong year, and quite frankly, we expect self-checkout to be a strong tailwind for several years.

Got you. And then just tell us about how the firm expands kind of the self-checkout product here in the U.S.? And then, you mentioned the airport deal, how is that one, essentially?

Sure. Yes, so we've been, as I said, primarily focused initially on building momentum in Europe. But as you rightfully put it, we're building a pretty nice pipeline in the U.S. However, I'll caution everyone, it is still early days. The win that we announced in Q1 with a large airport convenience store retailer was largely one because of the modularity of our self-checkout solutions. It also has an open architecture that works with prior software versions that the retailer may have deployed as well as offers very, very easy implementation and integration. In that particular case, we ended up displacing a large Japanese competitor, and we happen to have also had strong relations with the parent of that airport retailer. What gets us pretty excited, Paul, is that when you take a look at the post-pandemic expansion plans of a number of European retailers, none of them are looking at large-scale expansion opportunities within the U.S. including one that we know very well that is looking at a couple of thousand incremental stores in the U.S., and we've seen a strong track record of them leveraging our strong track base and execution track record in the Europe and following them into new markets. And we think that, that's an important level for us as we look at U.S. expansion going forward.

Okay. And then as we think about when you're selling these self-checkout solutions, what's kind of the gross margin profile on the services and solution? And then how is the average cost kind of compare to a POS device versus a whole self-checkout solution?

Yes. We don't break it out in granular terms. So let me give you a few ways to think about it. Historically, when I looked at the 2 businesses, Banking and Retail, Banking operated with considerably higher gross margins than Retail. Now I'll tell you that the gap between those 2 segments has narrowed considerably over the past couple of years, due in part to our DN Now initiatives but also due in part to our Retail mix shifting in favor of self-checkout. And when I take a look at the average selling price of the self-checkout unit compared to a point-of-sale device, it's typically 2 to 3x greater than a point-of-sale device for cash and -- cash on a sale of self-checkout devices, which delivers a considerably higher product gross margin for us. Where we also get a benefit on the lift in self-checkout is a substantially higher services attach rate. Typically, for self-checkout, we will see a 90% services attach rate compared to roughly 30% on the point-of-sales piece. So we start to see that as really having a positive mix impact on our business as self-checkout grows at a very, very good flow.

Okay. That's very helpful. And then as we think about the kind of competitive dynamic in self-checkout, both here in the U.S. and international, who are some of the other players besides NCR and Honeywell? And are the barriers to entry quite high as that demand kind of accelerates?

Yes. Like most aspects in Retail, the self-checkout business is competitive. And you mentioned, NCR is obviously one of them. We do start to see other competitors from Japan, players like Toshiba and Fujitsu. However, where we see ourselves having a strong advantage is it's not only having a highly competitive hardware offering, but it's also complementing that with a very, very strong services offering. And the combination of those 2 are critically important for high-volume, mission-critical retailers that want their checkout lines always working and always operational. And that's what we look to build on whenever we try and win a new account or whenever try and work into new market. That being said because of the importance of both of those success factors, the barriers to entry and moving into a new market are not inconsequential, and which is why we're encouraged by our early progress in the U.S., but we'll continue to moderate that until we can build a stronger track record.

Okay. So the pandemic impact had a somewhat accelerated demand for self-checkout. Let's kind of move to the Banking side. How did the pandemic impact the business there and demand? And where do you stand today on -- I know you're up for a big upgrade cycle. Where do you stand on DN Series, kind of certifications, orders, shipments? And then how confident are you guys for reaching that goal on DN Series?

A lot of questions there in one sentence. So I'll try and remember all of them. So from a demand perspective, Paul, we started to see strong demand for ATM start to build in Q3 and Q4 of last year. And it's continued into the first part of 2021 with a large part of that momentum unsurprisingly coming out of Americas. Although there were parts of Eurasia that showed strong growth, too. So we've started to see large banks in the U.S., large banks in Brazil. The regional banks in the U.S. started to accelerate their capital investments. Eurasia, quite frankly, a little bit more mixed with strong growth from some of the more industrial nations, strong growth from the early-stage developing markets with more muted growth from those markets that are still in various stages of lockdown, especially those countries that are heavily tourist dependent. That being said, we are feeling very, very bullish about our competitive position as a result of DN Series. We're starting to see good evidence of winning market share at the expense of others, in particular, with the large U.S. banks, where we're seeing banks buy from us that haven't historically bought from us. And when we take a look at our certification progress, we prioritized our certifications relative to banks with the biggest volumes. And most of those are all behind us right now. And we've also certified with the large U.S. network processors. So we're feeling very encouraged, and in light of that, we're very confident that this year, 50% of our orders shipped will be DN Series, and that will continue to grow through 2022.

Okay. And then how do we think about kind of the ramp? Is it going to follow a similar second half strength for some of these ATM deliveries? And then, yes.

Yes. Historically, if you've looked at our pattern, the first quarter would have been the weakest quarter of the year followed by the fourth quarter being the strongest. I think this year, it might be a little bit more evenly balanced. We're seeing good activities in Q2 and Q3. So I don't think the year will be quite as back-end loaded as other years, which is commensurate with the demand that we're seeing from customers. I think the one area that we continue to keep a close eye on, Paul, is, while the demand environment is looking very promising, we continue to watch the supply environment very closely. Right now, anyone that's involved in technology is well aware of the global shortages around semiconductors. Those are certainly a situation we continue to risk manage very, very well at the moment. But if there's any increased contraction in availability of semiconductors, that would certainly introduce a few headaches for us. But net-net, the overall demand environment is looking good as we think about Banking going forward.

And can you remind us kind of how your -- what your manufacturing footprint, where it's located? And how you're dealing with any shortages if they do come along?

Yes, sure. So back in 2019, we consolidated our manufacturing footprint to the point where the majority of machines are constructed at our highly automated and roboticized plant in Paderborn, Germany. We also have a joint venture manufacturing facility with a partner in China and final assembly facilities in the United States and Brazil. So that's really a few comments on our manufacturing footprint. As it relates to any potential component shortages, we've slightly increased our net working capital for the first couple of quarters of this year to make sure we're doing the appropriate level of risk-based buys to make sure that we've got further visibility into things like semiconductor chips. We are prioritizing deliveries to certain types of customers in certain types of markets. But all the actions that we know that every other manufacturer is undertaking as well. But as I said, from where we sit today, it has no bearing on our full year revenue guidance. We think we're managing through it. It's certainly something we continue to watch.

And let's talk a little macro. I guess, more specific, though, from your regional bank demand, where you -- what kind of comments can you make about that channel? They are kind of a higher-margin contribution vertical for you. And then with interest rates rising, budgets in a good place, do you expect more CapEx and OpEx from banks in the coming quarters?

Yes, Paul, we actually are quite encouraged by the macro environment for U.S. regional banks for all the factors that you just made reference to. As we've seen how that demand environment has translated into the first part of 2021, we've seen a good uptick in activity. I think in 2020, some of that demand environment contracted as regional banks took stock of how they were going to cope with the pandemic and started to snap back quite nicely. But as I said earlier on, the area where we've actually seen even greater demand has been with the large global U.S. banks. That's snapping back even faster. And as we look out to the next few quarters, we expect the regional banks to continue to pick up steam as they invest in recycling technology, video technology and continue down the refresh path.

Got you. So you've had some big upgrade cycles with deposit automation. You've had transformation as a pretty big theme. So you also have the new product coming out this year, which is a nice kind of upgrade somewhat. But in terms of the industry overall, what are your expectations for kind of ATM shipments over the next 5 years or so?

Yes. So obviously, one needs to remember that we operate in 130 different countries where the demand environments are really quite different, and the demand for cash is quite different. So yes, when we aggregate all of that up and we look at third-party research that complements our own point of view, it's very, very evident to us that -- and we anticipate a steady demand for ATMs over the next few years with roughly 300,000 new machines coming to market each year according to third-party retail bank research data. We see banks refreshing all the technologies as they digitize and automate their core processes and as they look to introduce newer capabilities like video teller access. So certainly, the refresh cycle is one part of what's driving that demand. But one also can't forget that there are a number of markets where financial literacy remains very low. And central banks in a number of those markets, and one can think of Egypt as a classic example, are strongly driving banks to increase the number of physical touch points for consumers, and that's driving incremental demand activity in those markets. So all of that net-net, I think, leans towards a steady demand environment for the next few years.

Got you. And then...

Sorry, Paul, maybe just add one other thing to -- not only do we see the demand environment being stable, but mix is an important consideration as well. Yes, as we look at the demand environment, we're seeing more and more demand for higher-end machines as banks look to further introduce recycling, video and other capabilities. And we believe that, that plays nicely to our advantages, given our -- that we have fourth-generation IP in recycling. And that's certainly something that we plan to fully leverage going forward.

Got you. And then just on your product portfolio as well, can you provide some kind of additional clarity on some of the cloud-native software solutions for both banks and retailers? And how your -- how you intend to grow that business as well?

Yes. So cloud native, there are several different products in our portfolio that I'll touch on, but let me touch on 2 that are probably more germane to the conversation right now. We're in market selling and deploying cloud-native video technology that's embedded on ATMs, and we're seeing very, very good uptake in that category, in particular, in the U.S. market. Slightly further down the road because of the duration of the sales cycle, we've been investing quite heavily in our cloud-native payment software, where we're working with large-scale global banks and helping modernize their payments infrastructure. We've gone live with a global top 10 bank which allows them to leverage our cloud-native payment processing capability to scale the number of transactions they can support, also allows them to reduce their total cost of ownership. And as importantly, it gives them a lot more flexibility to ingest new payment types that are continuing to emerge globally. So we're starting to see good interest from technology-centric banks. And obviously, we'll look to provide more updates to the market as we build momentum there. But I'd say those are the 2 areas we're most focused on in the near term.

Got you. So let's move to the income statement a little bit. So the quality of earnings has really improved materially, I don't know, with around $50 million in restructuring costs expected in '21. That's come down quite materially. Are we done with kind of these large restructuring and other kind of expenses as we move into '22 and beyond?

Well, Paul, let me first say, I appreciate your comments on the quality of earnings improving. It's certainly something we put a lot of focus on. Candidly, in 2019 and 2020, there was a lot of heavy lifting as we looked to transform the business operations. And we needed to incur a fair number of cash expenses as part of that. As we look at 2021, a lot of that tapers off, and we will incur no more than $50 million of expenses as part of restructuring. That doesn't mean to say there aren't further opportunities for us to continue to become more efficient. They certainly are as we look out over the next few years. That being said, I don't anticipate those initiatives to require anywhere near the level of restructuring expense that we've been incurring. And that's important to us because as we look to bring down our restructuring, that's an important contributor towards us continuing to drive up the free cash flow yield from the company.

Great. And then as the balance sheet and income statement have improved, where should we start to see reinvestments kind of trickle back in OpEx? I mean you're already doing it, but particularly in R&D as we move past '22 and beyond?

Yes. You know what, Paul, for the past 3 years, while we've been doing a lot of heavy lifting to transform the business, the one area that we have not cut back on has been on any R&D end. I think the market progress that we're seeing in DN Series is evidence of the impact of the R&D investments we're making. We didn't make any changes to our software R&D either. And in fact, when you take a look at our plans this year and our CapEx investments, our CapEx this year was substantially higher than last year as we continue to make investments in moving more of our infrastructure to the cloud. We also, within our SG&A and our COGS lines are investing in the cloud-native payment software that I talked about as well as managed services. So I wouldn't describe it as trickling back in. It's definitely starting to build back into the business, and we're starting to see that translate into stronger growth.

Okay. And then as we kind of think about free cash flow, is it on track for that guidance for '21? And then what kind of factors could actually present higher in your view?

Yes. We're very, very pleased with our progress on free cash flow, Paul. Last year, we delivered $57 million. This year, we're targeting $140 million to $170 million and are squarely on track to be in that range. A couple of things could push it higher. If we see a stronger demand environment that may drive higher EBITDA, that could push it somewhat higher. That will be potentially a little bit offset by a slightly higher net working capital to account for some of those risk-based buyers that I talked about, given the semiconductor topic we've mentioned. But from where we sit today, we think we're squarely in that range.

Okay. And then this is a very important question for a lot of debt investors. But when can we expect kind of more aggressive delevering as interest expense is really your biggest drag on free cash flow?

Yes. We're fortunately very, very well aware of that. As a result of the transformation that's being underway, we've reduced leverage from round about 6x in Q2 of 2018 to right now, it's sitting around 4.4x. And we still are of the view that we'll be sustainably below 3x by 2023. That deleveraging will largely be fueled by the increased growth in free cash flow that we've already talked about. But you're right, we are still burdened by a higher interest expense than we'd care for. There are opportunities for us to refinance our debt stack. Realistically, we will continue to be opportunistic and look at ways to optimize that, but we'll most likely be looking to act on that some time in the second half of 2022, subject to the market and other conditions. And as we go through that, we'll likely look to seek a better balance between euro and U.S. dollar-denominated debt in order to improve our interest deductibility.

Got you. And then post this possible delevering in the second half, how will your priorities change once you hit that 3x mark in terms of cap allocation in general?

Yes. We operate in a dynamic industry where the competitive journey continues to evolve. So we will continue to keep our eye open to potential tuck-under acquisitions that will continue to support and enhance our competitive differentiation. But for now, our focus is on generating incremental free cash flow to delever.

Okay. And then in the future, where would that kind of targeted CapEx and OpEx go to? You mentioned the cloud-native part of the business. And what other initiatives should we be thinking about?

Yes. We've spent time talking about the banking software investments that are already underway. There's 2 other areas worth mentioning. The second would be within Retail, we continue to enhance our capabilities in self-checkout as well as Retail software, where we're building a cloud-native platform primarily, and initially, for fuel and convenience retailers. And then the third major area of focus will be around managed services. Now both across Retail and Banking, we're seeing a growing interest from our customers to want to outsource larger parts of their estate to scale-based players like ourselves. And in the case of banks, they're looking to take parts or their entire ATM operations and outsource it to players like us, which allows us to capitalize on a broader TAM than we've historically capitalized on. That's an investment that started to build for us in 2020 and will continue through 2021 and into the future.

And can you tell us a bit more about AllConnect Data Engine? And what that's all about as well?

Sure. So for people that are a little less familiar with us, if you look at our journey, we've made just superb progress in our services business and improving our services margins from 21% to right now, they're sitting around 29%. Our AllConnect Data Engine is the next-generation of capabilities in our services business that will allow us to deliver greater value to customers as well as improve our own efficiencies. Now what it is at a high level is a model whereby we ingest meaningful amounts of data from all of the machines that are connected into our data analytics platform. That data is leveraged by our predictive analytics engine, which allows us to understand why is the machine breaking down, which specific component is broken down, and to limit the number of times we need to roll a technician and their truck to repair it. What we're seeing is very, very good progress in significant reductions in outages for machines that are connected to our AllConnect Data Engine. So that delivers great value and availability to customers. And on our end, because we are rolling trucks less frequently with fewer incomplete calls, we can see a clear path towards driving up our services margins. And at this state, that's the primary driver that will support us achieving increasing our services margins to a midterm target of 32% to 33%. And it's primarily because it's reducing the number of calls per device as a result of leveraging IoT capability.

Got you. So I have another question. How has the kind of pricing environment been for both ATMs and also services. You've seen your competitor kind of change the way in which they collect in terms of cash on services contracts. So how is that helping the industry overall? Are you seeing pricing a little bit more rational than prior years?

Yes. Yes. I'd say that probably for about the past 24 months or so, Paul, we've seen pricing be broadly rational in most markets. There are a small number of markets in the kind of Middle East area and in certain parts of Asia Pacific where pricing is still tricky in part because of some actions from some Asian competitors. But for most markets, especially where profit pools are the largest, yes, we've been pleased that pricing has been rational and more stable. And I'd say, if anything, we're seeing it be in an environment where we're able to generate higher pricing per unit than we would have in the past. Our DN Series is typically pricing at a premium to our legacy ATMs and that appears to be holding at the moment. And in Retail, Retail is always a very, very competitive space. And we always continue to look to make our devices more cost efficient, but pricing has also been pretty stable in Retail as well.

Okay. So I think that's pretty much all I have for you today, but thank you for your time. Is there anything you want to say to kind of wrap up today?

Yes, Paul, I think that hopefully, the key message that people take away is, we're feeling very encouraged by our competitive position, and we believe we have the market-leading hardware and ATMs. And we believe we've got strong differentiation in self-checkout. And our services proposition with AllConnect Data Engine, we believe, gives us a long-term competitive differentiator relative to others. So point 1, competitively, we think we're well positioned. Point 2, the demand environment is looking very favorable, and we're encouraged by the buying signals we're seeing from banks and retailers. And that's encouraging as well. So all in all, we're starting 2021 on a better footing than we had in prior years, and we're very encouraged by that.

That's great. And we were talking before, it sounds like you are even traveling a lot to kind of meet customers and things like that. So that's very encouraging.

Well, I wish I was traveling globally to meet our customers outside of the United States, but I'm certainly starting to ramp up my travel within the U.S. to meet customers. And it's great to be back in front of customers again.

That's great. Okay. Well, thank you for your time today. I appreciate it.

Paul, thank you. Take care. Bye-bye.

Bye.