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

Good morning, and welcome to everyone. I'm Ana Goshko from Bank of America, and welcome to our 2021, unfortunately and fortunately, Virtual Leveraged Finance Conference this year. And -- but nonetheless, we're thrilled to have Diebold Nixdorf with us with the company's CFO, Jeffrey Rutherford. So without further ado, let me welcome Jeff. And Jeff, let me ask you, to start out, even though I think our audience has a pretty great degree of familiarity with Diebold Nixdorf, just in case we do have some newer investors joining us today, could you start by providing a brief introduction overview of the company?

Sure. And thanks for having us. It's a pleasure to be here. So Diebold Nixdorf is a 150-year-old company that is in the product and service and software business for banking and retail. Primarily in -- concentrated in the Americas and Europe, and the Middle East, but we do have some level of Asian business, that's the smallest piece of the business. Basically, what we do is, from a unit economics perspective, it is we supply ATMs to financial services and banking customers. And then we provide -- there's a high attachment to service and software associated with those ATMs. It's the same for retailers in self-checkout and point of sales. So we are in the business of supplying our customers with those products, servicing those products, and also providing [indiscernible] software. And we can get into whatever expansion in detail you want on that. But generally speaking, that's what our business is.

Okay. Okay. Great. So for the ATM side, which from a product and even more so from a service standpoint, comprises the majority of the company's revenue. What's your market position? And then really, I have the same question as well on the retail side.

Yes. Our market position, if you exclude China and certain portions of Asia, is we share the market with our direct competitors, NCR. And from an ATM perspective and installed base are relatively equal to them with -- and as you move into Asia, you get into some of the Asian competitors, Hyosung and others. So we, basically, in the U.S., in the Americas and in Europe, our main competitor is NCR, and we share the market with them. From a retail side, it's a little different. The retail business for Diebold Nixdorf is [indiscernible] concentrated in Europe. Wincor Nixdorf is in the retail business, so we have a strong position relative to retailing in Europe where the NCR is also competing. But we have -- we can name the top 25 retailers in Europe as our customers. We have a strong position relative to point-of-sale and self-checkout in Europe. Whereas, in the U.S., where Diebold was not in the retail business, and we do have plans, and we are working to come into the U.S. market, NCR is dominant in the U.S. market.

Okay. And then when you look at it from a kind of hardware attached services and software perspective. How do the ATM and the retail business models differ?

Yes. So first of all, we sell in over 100 countries. We service in just over 60 countries. So I'm going to talk about those 60 countries where we do -- where we do provide service. In the companies -- in the countries where we don't provide services, we sell through distributors and they provide the service. But in the 60 where we provide -- 60-plus where we provide services, so from an ATM perspective, the attachment to services is relatively high. It's in the mid-90% range. And there are certain banks that still service their own ATMs that we don't have, and there are certain banks that will go through a third party for servicing. But the attachment rate is very high in service relative to installed base of ATM. For software, the terminal software side is a high attachment. The software that actually runs the ATM. And then as you move up the chain, you get to what's called terminal driving, that's looking at the transaction and redirecting where the transaction would go, we have a strong position there. And then beyond that is switching software, which we do provide but there's a lower attachment. As you move up the software chain, there's a lower attachment rate. When you look at Retail, it's starting with self-checkout, which is a growing market for all the participants in self-checkout. It's an extremely high attachment rate for service to self-checkout. It's in the -- it is, again, is in the high 90s. Software is not as high as an attachment in Retail as it would be in Banking. And we have more of an open architecture relative to our self-checkout. So there is capabilities using other software, but there is -- and we are migrating, most of our software [indiscernible] to the cloud. There is some level of attachment but not as high as banking on the software side. Point-of-sale is completely different. Point-of-sale, the attachment rate is in the 30% range. Point-of-sale really is a CPU at this point in time, and many retailers use other services to or other service suppliers to service those point-of-sale units, but again, the attachment rate of service is about 30% for us.

Okay. Great. So that was great by a way of introduction. And I also wanted to tell the audience that there is a tool for you to submit questions, and I'll be monitoring that to be able to address ones that come in that we haven't covered. So let's dive in. So given how topical supply chain issues and constraints and cost inflation are right now. Let's start with the discussion on how Diebold Nixdorf is being impacted and navigating this environment. And then we can broaden the discussion -- have a discussion, just some bigger picture topics. But could you describe current backlog levels by segment versus normal levels? And is that backlog now starting to ease at all?

Yes. So let me give some context as to why this is an issue for us from the materiality perspective. We introduced a high-end ATM called the DN Series ATM. And just for context, the DN Series ATM is a -- an advancement forward in ATMs. It's the high-end ATM and DN Series, is a cash recycling unit. And as the banks and financial institutions move more towards self-service, customer self-service, this has proven to be an attractive device for them to do so. But we primarily manufacture those high-end ATMs in Paderborn, Germany, which is a highly robotic, automated plant, but it's in Paderborn, Germany and our biggest market is in the United States. So from a supply chain perspective, it's caused delays in delivery of ATMs. We talked at the end of the third quarter that, that was going to push [indiscernible] push approximately $120 million of revenue out of '21 into '22, due to the delays in assembling and delivering those high-end ATMs to the -- mainly to the North American market. The solution for that is through the final assembly. We do have a plan in the United States to the final assembly for the legacy Diebold ATMs. That plant is converting over to the DN Series high-end ATMs. We're in the process of doing that they are producing those ATMs in-country, in the U.S., and that is ramping to the point where it should be at a relatively high level by the beginning of 2022. That will relieve some of the pressure relative to the supply chain moving of ATMs from Paderborn to the United States. And so that's on the ATM side. On the Retail side, remember, Retail is heavily concentrated in the -- in our European customer base, although we are seeing forays into the U.S. as the European retailers in the U.S. are adopting self-checkout and they're piloting self-checkout. You can see our self-checkout units in IKEA, in Hudson stores, in the airports. And there are some pilots being run by all the [indiscernible] in the U. S., but it's primarily in Europe. So there's [ around transportation in Europe. So there is around transportation ]. It's not as big an issue. The issue for retailing, and this also affects ATMs' inbound electronic components, sourced electronic components, right? And many of those are coming from China. So there are delays in that inbound. But it has not been nearly as significant as the outbound delays from Paderborn to the United States. So what we're seeing is when we talked about $120 million of revenue moving out of the '21 into '22, and we're also experiencing inflationary costs, especially in logistics inflation, mainly containers and sea-bound vessels. We talked at the end of the third quarter that the inflationary costs associated with supply chain was going to be somewhere in the range of $45 million. And that's primarily 2/3 of the -- 2/3 of that is logistics, both inbound and outbound logistics. And the rest is related to the electronic components that I talked about, including semiconductor chips, where -- and when I talk about semiconductor chips, I'm not necessarily talking about CPUs. And every ATM has a CPU. And then there are sub-chips, operational chips that exist in every ATM. And the more complicated the ATM, right, the more chips you're going to have. But I'm only talking in the range of 4 to 5, it's -- Tesla has a thousand, right? We have 4 to 5. We do not buy those directly, we buy them through secondary sources and inflation has been fairly significant in that. So the other 1/3 of the $45 million relates to the inflation of semiconductor chips and other electronic component costs that we source from third party.

Okay. So just a good overview. Just a couple of follow-ons. On the inflation side, is all of these transitory? I would expect not. And then to the degree that it's really sort of a structural increase in the price of components, are you planning price increases to counter this?

Yes. Yes. So we made the business decision relative to the equipment that we were delivering in '21 and is carrying over into '22 is to not go back and renegotiate prices with our customers. But going forward, there will be price increase, right? And we're not only experiencing logistics and component part inflation, we're experiencing wage inflation. We have over 8,000 service technicians globally. We have -- globally, we have over 1,500 software developers. So we are experiencing both wage and logistics and component part inflation. So let me go through the different categories of the business and I'll tell you how we're handling this. With our service contracts, and again, going back to what I said earlier, the high attachment to ATM -- I'm sorry, attachment to self-checkout, there are service contracts associated with that. Generally speaking, those contracts are either annual contracts. And for larger financial institutions, they can be longer-term contracts. But regardless whether it's an annual or long-term contract, there's the ability to adjust pricing for inflation. And what we're talking about here is wage inflation and spare parts inflation. So we -- and the renewals occur at this time of the year. In fact, we're coming to the end of the renewal period. We've gone back and implemented our ability in longer-term contracts under the contract to raise pricing relative to inflation. And we also have gone through with those renewals and raised prices appropriately. We're not disclosing what those price increases are, but you can imagine based on where the wage inflation and what the target would be. On product, what we've done is we've got 2 product categories if we think about it. We have the DN Series ATMs, the high-end ATMs, the cloud-enabled Cloud Connect ATMs that have been very attractive in the marketplace. That's [indiscernible] over 70% of what we're delivering or what orders we're taking, it will be 50-50 basically for units delivered in '21, it will be 70-plus percent, and DN Series going forward. We use a market pricing techniques for those ATMs because it comes from where they sit in the marketplace as superior products. So we're looking at what the markets will attract relative to freight or what the market will allow relative to pricing increases. So we are putting through price increases on the DN1 or the DN Series ATMs. On the legacy ATMs, we just raised the prices. In fact, we -- I can say, we raised it 5%. We're probably raising again. And we're going to -- we're going to transition our customers out of those legacy ATM, simplify the supply chain manufacturing processes, installation processes by converting all of our ATMs over to DN Series ATMs. And we'll -- by the end of 2022, we'll be at a very high rate of ATM conversion. The only ones that possibly could remain in non-DN Series would be the low end, low end cash distribution ATMs, not the recyclers. And those are manufactured for us to generally out of our Inspur partner in China. So we will put price increases through on services. We will put price -- we are in half, we are putting price increases throughout ATMs, which increases throughout ATMs [indiscernible] from a market perspective on self-checkout. And then the last piece is software. Software is maintenance, license, and professional services. We are increasing prices on professional services. It's directly attached to labor rates. And then we're working on what we're going to do relative to maintenance, but that's less of an issue relative to any inflationary effects in the software maintenance. You will see, in the beginning of '22, you will see price increases coming through because we do believe that this inflationary effect will continue in and wage inflation through, obviously, through '22. We believe that we're going to see some level of relief and a release in the supply chain backlogs probably after the Lunar New Year. But we are currently modeling for the logistics and [ component ] parts inflation the last through -- throughout 2022. And then we'll get some relief in the '23.

Okay. Though you did state that you believe that 3Q was the inflection point. So hopefully, getting better post 3Q.

I think the grass root will level out. I don't -- we don't expect them -- there's a lot of attention on supply chain, right? You can pick up the Wall Street Journal or watch 60 Minutes without some story on supply chain. I think there's a lot of attention to it. I think there's even governmental and political considerations. I think we're going to see some relief of backlog post the Lunar New Year, but I think the cost we'll see relatively high and then start to decline in the back half of 2022, and go back to -- go somewhere to a new normal. I don't think they're going to go all the way back to the prices of 2020, but there's going to be a new normal that we have modeled, we'll see the impact in '23.

Okay. So switching a little more of the growth outlook, but still, unfortunately, on the supply chain topic. Do you -- how is this impacting your orders? Have you -- are you losing orders? Are your customers being patient? Let me just leave that question open to you.

Yes. We have very good relationships. And we are basically talking about the U.S. banks, right? And I think people understand the issues associated with the supply chain delays. I'm not sure that they're all are patient, but they understand it. We have expedited certain deliveries to customers. If the customer is opening a new branch, we're going to get the ATMs to them, right? That means air freighting, which is extremely expensive for a product like an ATM, we airfreight those. So part of what I talked about in the inflationary cost, there is airfreight to the Americas factored into that to deliver ATMs or deliver ATMs where they're critical for a customer. So if a bank is opening a new branch in New York City, we airfreight the ATM to make sure they have for their branch opening. We haven't lost any confirmed orders. So you don't, as far as we're, as we had confirmation of an order, we had delivery times for 2021 that get delayed to 2022. We haven't lost any of those. Our customers have been understanding. They've been helpful. We have, in fact, we have a large U.S. customer that is willing to pay for their ATMs that are in the pipeline. It's not revenue recognition, but from a cash perspective. So we are getting -- this is a credit to our sales organization and our sales leadership. We are getting -- we are in good response and supportive response from our customer base. I wouldn't say they're all happy, but there are certainly understanding.

Okay. I think on your last earnings call, you said that confirmed orders for the first half of '22 are above the prior year's level. So what's driving that? And can you break it down between the ATM and the Retail side? [indiscernible] are that you may be seeing a pull forward given the known delays on the banking side, but also wondering if there's a kind of an ongoing demand tailwind for self-service on the Retail side?

Well, there's demand for self-service on both sides, right, and -- both banking and Retail. That's the trend. Certainly, on Retail, there's a strong demand for self-checkout. And the self-checkout market itself is growing, we're growing faster than that market. We haven't talked about what our growth targets are for 2021, 2022, but it's going to be higher than the market growth because we have such high demand and such good relationships with -- especially again with the European retailers. So we all expect a very good self-checkout growth in 2022. And we're going to have a very good self-checkout growth in 2021. From a Banking perspective, we see growth into cash recycling versus cash dispense. Cash recycling now, for us, and cash recycling is more of a self-service ATM. It says ATM that you can deposit cash into, you can deposit checks into, you can withdraw, you can do other transactional activity on the ATM. And so there's a -- it's a very attractive for banks relative to total cost of ownership in relationship to labor costs, as labor cost increase and labor, let's face it as it is difficult positions to fill self-service to make sense for both retailers and banks going forward. Cash recyclers now are the dominant ATM that we sell in all markets with 1 exception. The only exception is Spanish-speaking South America. In every other region of the world, including Brazil, where we sell ATMs, the predominant product is the cash recycling units. And that's because banks are converting and training their customers relative to self-service versus tellers, drop box and other things. So we see -- that's the high demand. That's where the high demand is coming from. And as both banking and retailing because of wage inflation, because of the difficulty in filling FTEs, self-service has become more prominent, and we have the kind of product that they want relative to self-service.

Okay. We have a couple of questions coming in from the audience. So one on free cash flow. And then second, on the debt structure. So just on the free cash flow side. So even though the company reduced the free cash flow guidance for 2021 based upon the supply chain challenges, there is a really big sort of target for fourth quarter. So the question on the free cash flow is what gives you confidence in being able to generate free cash flow in the fourth quarter? And also, what, to your level of confidence, that you'll be able to generate positive free cash flow in 2022?

Yes, I'll start with '22 and work backwards. 2022 is a clearer picture because we're no longer going to have any restructuring transformation cost in '22. It ended in '21. We spent -- we're going to spend $50 million in '21 on restructuring. We spent approximately $140 million in 2020. It's going to be $0 in 2022. So we automatically pick up $50 million from our cash flow going into '22. When we look at -- and then I'll come back to '22. When we look at 2021, yes, it's a big number. And the pressure on '21 free cash flow is related to inventory. So we talked about $120 million of revenue is shifting from '21 to '22, we have that inventory. We just can't deliver it for revenue rate. So we're going to carry high inventory through year-end. Normally, at year-end, when the holidays come around, we've delivered the product. We're going to deliver, we cut back on -- the plant's closed for the holidays. This year, it's a different situation where we continue to manufacture. We're going to carry high inventory. The offset to that, there's 2 places. One, I [indiscernible] mention it that certain customers are willing to prepay for product. And that could relate to their internal situation relative to the capital budget and so forth. But we have customers that are prepaying for a product that is on its way to installation and revenue recognition. So you're going to see that. You see that on our balance sheet as deferred revenue. It's a common practice within the industry, our competitors have it too. And generally speaking, because of low-cost capital, there is a -- there are a number of banking customers that have old prepay on contracts and prepay on product delivery. So we're taking advantage of that this year. And then the other -- the flip side of it is, there are certain vendors, obviously, that they get paid when we get paid a kind of deal. And so you're going to -- what you're going to see is a higher level of deferred revenue because of prepayments from customers and some expansion and leverage, AP leverage as we go through the year-end. And our customers, we have a great customer base. That's one of the things about this model that is different to some of the other models I've worked with over the years. And this is by far the best customer base I've ever had the ability to work with. So it's the global banks and global retailers, mainly the European retail base. And they're good relative to payments the of their bills. And that we put a little bit of a push [indiscernible] in December, and we're in the middle of that now. So we feel comfortable that we'll get to that number based on those factors. Back to '22. So we'll start '22 with a $50 million head start because we won't have restructuring transformation. The goal for working capital for '22 would be to the unwinding of the inventory excess as that the U.S. plant ramps up and we get to an equilibrium relative to deliveries, we shouldn't be carrying that excess inventory beyond '22. So that will come back through from a positive perspective and then the unwind of the AP leverage and the deferred revenue would offset that, so our goal would be to be relatively flat in working capital by the time we get to the end of '22 with where we will end up in '21. And then with the continued expansion of margin, we're not going to have revenue issues. Obviously, we're pushing $120 million of revenue out of '21 into '22. So '22 will have a good revenue year, continued expansion as we do digital applications within services and use of AllConnect Data Engine will expand margin within services. We'll have a good EBITDA year. We haven't given guidance. I know people get disappointed when I don't give guidance on these calls, but we're not providing financial guidance yet. But we will see growth in '22. We will see the elimination of restructuring in '22. And all things considered, we think we can get back in '22 to our targets for -- that we had for '21. We're sure going to have some inflationary effect in the model. But certainly, we put out a target of 30% for '21, and 50% for '22, '23. I think what all this is done, is delay about a year, but those targets are still in line. This is a model that should be generating 50% free cash flow. It's hit a speed bump relative to supply chain and inflation, but we'll get that model back to where it needs to be through what we already talked about relative to pricing, relative to other margin expansion opportunities, both in all areas of our business. And cost mitigation as we move to a more digital structure relative to the back-end processing that we still feel very good about this model being able to generate 50% free cash flow. That is not going to be in '22, but it could be sometime in '24 to get to 50% free cash flow conversion.

Okay. It's very helpful. So unfortunately, we're hurry at this time. So this has been very helpful and appreciate you joining us. I mean, so because this is a debt conference, I just want to run over a bit here. So we do have a question about the company's plans with regard to refinancing its current debt. You've got the high coupons, especially on the secured bonds with the 9% handles, those are not callable until July of 2022, which hopefully will coincide with improved supply chain conditions. So I think you've been pretty clear that the game plan is to look at refinancing the structure at about that time. So just want it to confirm that's still what you're thinking? And then any closing comments that you have would be great.

Yes. I would close, I know you're [indiscernible] for time. Anybody has any questions on capital structure can certainly give me a call, but some -- it is reasonable to assume that sometime between now and the third quarter of '22, we'll be in the markets addressing our debt capital structure. We have to rebalance between the U.S. and Germany, relative to deductibility of interest. And based upon market conditions, there's all indications that we'll get a favorable trade on coupon. So sometime between now and then, you can expect us to. And we'll certainly be interested in the marketplace and inquisitive, but from a -- it's reasonable to assume that we'll be in the markets, next year.

That's great. Okay, Jeff. And any final comments or...

No. Anybody has any questions want to reach out to me directly. I answer those capital structure questions every day. So I welcome the questions, and thanks, everyone, for your time and attention, and we'll talk to you soon. Thanks.

Okay. Thank you. Thank you so much. Bye-bye.