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

All right. Good afternoon. So my name is Paul Chung. I'm the applied emerging tech analyst here at JPMorgan. I'm pleased to have the CEO of Diebold Nixdorf, Octavio Marquez.

Thank you, Paul.

Yes. Thanks for coming. So I guess just to start, can you kind of provide a quick overview of the company.

Sure. So first, thanks, everyone, for joining us today. So a very quick overview of our company. So we serve 2 markets, primarily, the banking and retail industries, two of probably the most competitive industries in the world. For banking, we provide self-service automation in the form of ATMs and ATM recyclers, software and a very strong global service base. And for the retail industry, we're very focused on self-checkout solutions. So -- our business is primarily European-based for our retailers, where we participate with -- with the top 25 retailers in Europe, and we're quickly expanding our retail business in the Americas as well.

Great. So can you just talk about your history with the firm? Why did you take the CEO job? And what you hope to accomplish?

Yes. So. So....

Sorry, I just wanted to mention, if you guys want to ask questions, feel free to kind of send them over and I'll try to intersperse them during the session.

So good question. So I've been with the firm now 8 years. So I joined the company 8 years ago. Because I truly believe that both the banking industry was on a verge of changing how they consume self-service technology or ATMs. Over that over these 8 years, I've seen us grow from just being financial services company focused on banking to acquiring the Wincor company doubling into the -- now into the retail world. And I'm truly -- I truly think that both bankers and retailers are looking to improve the customer experience significantly. And I think that our self-service technologies accomplish that. And the other thing that I think is interesting about our business is that self-service is also a great way to avoid cost in tight labor markets. Self checkouts becomes one of the top priorities for retailers. And in banking, as banks rethink their physical footprint, the use of recycling technologies and ATMs allows them to really start serving other parts of the market in a more efficient way.

Okay. Great. So let's jump in about the company. So just on the macro kind of level set, how is the firm now kind of navigating through some of the component inflation, freight, what's your visibility now post and print? And how are things improving?

Yes. So I think, Paul, it's good to take a step back and see how our demand environment is evolving. So when I look at Q4 of last year, we had record sales for both ATMs and self-checkout. When I look at Q1 of this year, we once again had a record quarter, growing significantly 23% year-over-year and about 3% or 4% sequentially, which is strange in our business because it has a lot of cyclicality, where usually banks and retailers procure at the end of the year. So growing sequentially was also very important to us. With that said, we've had challenges in delivering the -- in turning those orders into revenue. Based one, as you were mentioning on supply chain issues with component shortages globally, something that we took action against late last year. And if you see our inventory levels, you'll see them a little bit elevated, and that's because we made the decision to invest in key components to secure that -- those components for the better part of this. Another thing that we're doing is with the inflationary environment that we have, we've gone back to most of our customers. We've taken, obviously, the appropriate pricing actions for current orders to have incorporated the price increases. The good news is that we've seen very little pushback from customers. So demand hasn't really suffered because of that. And what we're doing now is reversing a decision that we made in Q4, which was not to reprice our backlog. We have over $1.2 billion of backlog right now. And we have made the decision not to reprice it. The reason why we did that was we were focused on delivering to customers and our model is very simple. Once we deliver the equipment with the software, we have very strong recurring revenues for many years. So we were very focused on, let's deliver the equipment and start those recurring revenues. With the current environment and inflation that we're seeing, we've taken the approach to go back to some of those customers and the $1.2 billion of backlog that we have. And we're giving them basically a couple of options. One, we can reprice that backlog to reflect the inflationary pressures that we've had. The second one is we're asking them to -- to prepay for that backlog. Or the third one is to cancel the order and then they can rebid it at a future date. We started this process early Q2 after we saw the inflationary pressures in Q1 and supply chain and logistic challenges. I'm happy to say that every customer that we've talked to so far has taken either option 1 or 2. So we see very little desire to cancel orders. And most customers are looking for a way either to take some of that price increase or prepay that equipment.

Okay. That's great. So I guess also on the staying on components, talk about the competitive environment. I mean, you guys are probably sourcing similar types of components. So -- how is that kind of trending now?

Yes. So I would say, Paul, last year was the more challenging here component-wise. That's why at the end of the year, we made the decision to really stock up our inventory levels. Because we wanted to -- we saw the demand coming. So we saw our sales teams signaling that there was strong demand ahead of us. So we made that decision to invest heavily in raw material, particularly microelectronics. That's a key component of our products, just to be able to support the upcoming demand.

Okay. And then kind of staying on that topic, just talk about your manufacturing footprint, you're kind of sourcing relationships today, where you're looking to make changes et cetera?

Yes. So today, our manufacturing footprint is very heavily European-centric. So our main manufacturing facility is in Germany. We also have a manufacturing facility in China and one in Brazil that serves the local Brazilian market. Middle of last year, we decided to invest in our Ohio manufacturing facility. So we've been ramping up our manufacturing capabilities in Ohio through the second half of last year. And our expectation is that by the end of this year, all the product that we will sell or 80% of the product that we will sell in the North America market will be sourced out of our Ohio facility. So our footprint will change and our European manufacturing will shrink a little bit. Our North America manufacturing will grow, and we will keep our China manufacturing for the lower end of our product families.

And can you remind me, are you mostly vertically integrated?

Yes. So we own all the IP for our products. Obviously, we have PCBA suppliers, component suppliers, but all the IP on our products is our own.

And can you talk about kind of the benefits of being vertically integrated, your near peer has chosen the outsourcing route?

Yes. So I would say that when you look at where the industry is going and what the technology trends are, banks are really looking on how to improve the cost equation. And we believe that recycling technology helps them do that. We're in the fourth generation of recycling technology. And for those of you that might not be familiar with that recycling technology is the ability to the same cash that you deposit into the machine is the same cash that gets dispensed. So we do see that as a competitive differentiator, something that banks have really started seeing the value, particularly in North America. And that's helping them automate the SMB customers. So we do think that owning the IP of what we manufacture is very important for us.

Actually, I got a question here. We've kind of touched on this. The sourcing of chips are -- has the chip availability improved and prices improved or declined after Q1?

So remember -- and sorry for repeating myself, but this is kind of the decision that we made. We saw how the chip market would remain very volatile in the coming quarters. So at the end of last year, we made the conscious decision to buy the key chips that we had been short of throughout the year to secure our manufacturing capacity through the first half of this year and probably until Q3. So that way we're a little bit protected about those fluctuations, and we've also secured the price that we were able to get last year.

Okay. Let's jump into financials. So talk about the trends you're seeing on ATM growth in branch counts. We do track some of that data, and it has been a little bit pressured during COVID. But if you could talk about where you see it going now after maybe some stress over the past 2 years? .

Yes. Clearly, during the pandemic, we saw significant branch closures or reduction in branch hours, which cost banks to rethink what does their physical footprint need to look like. I think that the good news is that as cash has proven to be a resilient payment method. During the pandemic, we saw cash volumes decline, but we've now seen them pretty much recover to the pre-pandemic levels. So banks are rethinking. If I don't need these big branches, can I have a different footprint of a branch, a smaller branch that has more automation? And when you talk about more automation, ATMs and recyclers clearly play a very important role in that transformation. So we're seeing a lot of interest, particularly interesting in the U.S. where big banks that had been some of the, I would say, laggards in adopting some of these recycling technologies are now at the front-front than most large banks are actively looking at implementing recycling as they change the footprint of their branches.

Okay. Yes, just sticking on that topic, so the top Tier 1 kind of demand trends, if you can kind of expand on that? And then separately, we can move into kind of the regional banks and what are you seeing there?

Sure. So when you look at the big banks, and I'll center a little bit in the U.S. and then we can talk internationally. But when you look at the top U.S. banks, they're all rethinking how they serve their customers. They're all rethinking their branch footprint or what services they offer in their branches. One of the last pieces that banks have been struggling to automate as the SMB customer. If you think about it, it's probably not any of us in this room that go into a branch on a regular basis. But if you own a small business, if you -- those are the types of consumers that constantly are in the bank branches. It had proven to be very difficult to automate those customers because with prior technologies, imagine trying to deposit stack of bills into an ATM, where in the past in an envelope and not so long ago through the slot. With recycling technology, you can do both deposit at the ATM, so you can actually put up to 400, 500 notes at the ATM at one time. You can do multi-denomination, so you can have up to 8 denominations of bills inside the ATM. So if you're a small, medium business, recycling technology and banks that are adopting it are actually finding a very good way to automate the SMB deposits. So that's a trend that we're seeing all major banks start doing. And as it usually happens in the U.S. Once the top banks start adopting a technology, it starts trickling down through the large super regionals and then eventually to the community credit union space. And again, globally, a significant portion of our business is also European-based, and most European banks have been avid users for self-recycling now for several years.

Right. So let's just talk about the competitive environment. So your installed base has been pretty steady over the years, where are you seeing kind of competition sprout up? I know NCR and Hyosung also pretty strong players. But what are your kind of expectations for overall market share over time now?

Yes. So Paul, I think that it's important to note that our installed base has been pretty steady. We globally have a little bit over 30% market share. The importance of keeping that market share steady is that our business is predicated also on our recurring revenue surround surface, which is the biggest part of our business and the highest margin part of our business. So what are we doing? . We're actively working on gaining market share. We just launched a new family of recyclers couple of years ago. That has proven to be very well accepted by banks globally. So while other competitors are not as focused on the hardware part of the equation, which talks to a little bit about what you were saying about integration and IP of your own products, we remain convinced that having leading technologies, both in ATMs and self-checkout for retail is important because that starts building a bigger base on which we deploy our services.

Okay. And then so let's just touch on the DN Series. You've talked about the kind of cash recycler competitive advantage there. What's kind of the average price ranges you have on this product? Where are we in kind of the cycle for the DN Series? And any key customers or partners you can kind of call out? I think we've been hearing as well as seeing some pickup in installations?

You said it not -- but no, clearly, DN Series, we launched DN Series 2 years ago. Great timing because no better time to launch a product than at the beginning of a pandemic, right? So clearly, we launched it, and it is a product that we believe is unique. The uniqueness is not just a recycling technology or that it's a smaller footprint, more ecological, less energy consumption. So we thought about all the things that we wanted to build into the product. But we also build -- and that's where when we talk about chips, DN Series has a series of sensors that actually are connected to our service organization through something called the AllConnect data engine that allows us to do proactive monitoring of the devices, predictive maintenance. So in reality, the combination of our hardware, our software and our services provides significant type uptime benefits for our clients. So it's not -- I would never just say DN Series, the hardware, even though it's superior to things that we see out there. I think it's the combination of the hardware, the software and the services that really provides an outstanding value for our customers. And I would tell you that we're in -- in my view, in the early stages, even though the ATM market is not a significant growth market globally, it is a significant refresh margin. So if you think of North America that we've been talking a lot in those -- this big bank that you mentioned, no they're thinking of refreshing their fleet, the same as kind bank that's a sponsor of this conference as well. So all these banks that are thinking of refreshing their fleets, provide a good opportunity for us to come with new technology and help them in that journey.

Okay. And then -- just talk about like the history kind of upgrade cycle. So '19 was a great year. You had Windows 10 upgrades, but you have somewhat of a gradual refresh cycle here with the kind of cash recycler. So that probably extends for quite some time. But where do you see kind of the next upgrade cycle happening? Or is it just going to be kind of this refresh of current fleets, percentage of fleets moving forward?

So I would tell you, '19 was a very strong year as many banks had to adapt to Windows 10. But I would tell you that if you think about that, that was probably the laggard banks, the smaller financial institutions that waited until the last minute to remain -- to become compliant with technology. If you think of the big banks, they were done with that upgrade cycle several years ago or before '19. So what we're seeing is that those fleets that were refreshed before '19, particularly large banks are now reaching that stage where they're 5, 6 years. And in most banks, after the 6 years, they start planning their refresh cycle. So I would tell you that right now, we're seeing the importance of that refresh cycle starting to materialize.

Okay. Another key kind of upgrade more -- a lot more ATMs connected to the cloud, cash recycling is also kind of reducing need for pretty routine maintenance. So how is this changing kind of your service offering, if you don't need them to kind of go out to service the machine as much?

So once again, the importance when we redesigned DN Series was that we created this ability for this remote diagnostics and some self-healing of certain components. So what this does for the banks is that we're able to provide better uptime for them. So at the end of the day, a bank doesn't really care if we go and touch the machine or if we can repair it remotely. The more that we can repair remotely, the less truck rolls that we have to have or the less technicians that we have to deploy, which obviously is accretive to our margins.

Okay. So let's just talk about overall margins. So talk about the kind of life of an ATM from purchase? From purchase to the kind of operating profit of the hardware and then services and software that are added respective margins there, which are higher and kind of the life cycles, of that relationship over time, how long is that whole kind of contract value of that?

Sure. So if you think about it, when we deploy an ATM and this is the public information that we report, our normal margin rate is somewhere in the mid-20s. The Q1 was a little bit of an anomaly with the inflation that we discussed in some of the logistic challenges that we had to overcome. But let's just assume that over the year, we will normalize our margins to that same level through the price actions that we've taken. So that's the initial purchase, where an ATM can range anywhere from a simple cash dispenser $5,000, $6,000 to a full function recycler, that's probably closer to $25,000, $30,000. So that's the initial purchase price. Around every ATM, we sell our terminal software, which is necessary to operate the ATM. So our software margins are in the 40% to 50% range. Remember, it's a combined margin between licenses, professional services and maintenance.

How high is that attach rate?

It's almost 90% of attach rate. So our software also works in devices that are not our own. So our software is multi-vendor. And some very large financial institutions that actually do that. And again, so we run fleets that are -- where clients don't have any DN hardware, but they do have our software. And then I think the important part is that that's the durability of our model. Once that device is installed, we have service contracts and our service contract margins have always been in the high 20s, low 30s. And the durability of that is a device lasts anywhere in the big banks that are more refresh, conscious and not keep refreshing their fleets at a faster rate, probably 5 to 6 years. And smaller financial institutions keep those devices probably 7 to 8 years.

Okay. And how is your kind of software offering differentiated as well as your services as well, I know there's a lot -- there could be some third-party service providers as well kind of coming into the space?

Yes. So that's why it's the importance of talking about the complete solution. So could somebody maintain the hardware and buy parts, probably. But we believe that the combination of our hardware with the AllConnect data engine to do the remote monitoring, all the capabilities of our field technicians. Remember, we're one of the few companies in the world that has a global service footprint. We operate in 60 countries. So when we think of the U.S., probably that doesn't seem like that important of an item since we say if we can cover the U.S., we'd be fine. But think of our global banks. Think of banks that operate in multiple countries, they want to have standard service agreements. They want to have common infrastructure to run that. So that's where I think a lot of value comes from our service operation. Around our software to try and wrap that up quickly, we believe that what makes our software unique is the approach that we've taken around APIs. So the easy integration of our software with other parts of the bank. So whether it's to do marketing at the ATM, whether it's to do cash forecasting. So we believe that this more modern API approach that we've taken around software is really what provides significant differentiation for us.

Okay. Let's talk about EV charging before we get into retail. So how did this opportunity come about? And how big is this market potentially, it's in Europe now, how big is the U.S. opportunity?

So I would tell you, and it's -- I guess it's a good segue after we talked about services. When you think about what is one of the assets we have as a company, it's this capability to have a global service base, where we have call centers, part depots and technicians in 60-plus countries. When you think of the EV charging market, and we've started in Europe because it's clearly more advanced the electrification of transportation in Europe right now. One of the challenges that both the charge point operators as well as the fuel companies have is as you deploy this distributed infrastructure, you need people to support it. So if you're deploying charge points in Germany and in Switzerland, it would be nice if the same company could actually -- that if you had one call center to call, one same number, one same level of services, I was actually talking to one of the large fuel companies in the world. And as they're deploying massively through Europe and Africa, one of their concerns was, if I want to make this scalable and operationally efficient, I need one provider that I can rely on to really help me service across the continent. If not I have to have small agreements in different countries, which at the end of the day, becomes very challenging for them to manage. How big of an opportunity will this be in North America? I guess that that's something that we're still investigating. But -- but what we're trying to do is make sure that the service infrastructure that we have that we can leverage that into the -- because the part depots, the call centers, the technicians, we can leverage and scale that. So we want to be in the early stages as this industry starts maturing and the service model is defined to be able to play an important part in it.

Okay. Great. So let's switch on to retail. So where are you seeing kind of pockets of strength by geography, by products. Talk about what differentiates your product. And then it's starting to get more and more crowded as you see a lot more competitors enter the market. Are you seeing any displacement of those competitors as well?

Yes. So I think that when you think of our retail solutions, once again, it's a combination of our hardware, our software and our services. So we've made a very conscious effort to be very focused on self-checkout. And this is something that we started several years ago. We believe that self-checkout was going to be the next big wave in retail. And it has proven to be accurate. We see every day more of the point-of-sale lanes being converted into self-checkout lanes. We've seen significant success in Europe. Remember that our retail business is very focused in Europe where we serve some of the largest retailers in Europe by around point of sale. So we've been very successful in converting them their point-of-sale lanes to self-checkout lanes. And we're also now seeing significant success in winning competitive bids with our self-checkout against other companies in Europe as well. The good news around that is that as we won some very large European retailers that are expanding into the U.S., we will now start developing a significant footprint of self-checkout solutions in the grocery industry, which I think will help us prove the point that our solutions are competitive globally. And once again, the benefit of our retail self-checkout is that it's a very modular approach. So it can go from being cash less to receiving cash within the same device. You can change screens, you can change scales. So it's a very modular architecture that we believe it resonates very well with retails as well as, I think, one key point is -- we've made the decision that our self-checkout through the use of APIs can connect to any retail back-end software. So whereas others want to self-check -- the self-checkout is very tightly coupled with the software. We've made the decision that, yes, you can use our software. But if you're using a third-party software or some other software, you can very easily integrate our solution.

Okay. And then talk about where we are in the installed base, how large is it? How meaningful it can it grow over time? And then once you do get in with the retailer with the self-checkout solution, it's quite sticky, I assume. And how long do you think those life cycles are of that product?

Yes. So when you look at the self-checkout growth globally, it's an industry, it's a market segment that's scheduled to continue growing in the mid-teens for the foreseeable future. So we do see that there's still ample room to grow in the self-checkout space. The good news is that contrary to point of sale where the attach rate of services is fairly low. Remember, a point-of-sale device is more akin to a PC. So the attach rate tends to be lower. But in a self-checkout device, the attach rate is very similar to ATMs, 90-plus percent. So it does create that sticky recurring revenue for us.

Okay. So I have a couple of questions here that came in. So what percentage of your services more recurring? And then how high is your attach rate given some -- you've seen service revenue kind of declining a little bit?

Yes. So our service revenue stream has 3 main components: one, which is our contract base, which as we discussed, that is very tied to our installed base. So that remains fairly steady throughout time. So that one, we would have to lose a contract in order to see a change in that. The part why you've seen a little bit of a decline in our service revenue in the past quarters has been as we haven't been able to install as much hardware -- the installation part of our business is the one that has suffered. So as we ramp up again and catch up on installations of our hardware, the installation part of our business will also start catching up.

Okay. Let's move on to the fun stuff. So free cash flow. What's kind of driving the breakeven guide there? Where could you possibly see some upside there? How much kind of cash restructuring is embedded in that guidance?

Yes. So remember, Q1, we changed our guidance based on a couple of facts. One, $80 million coming out of Russia and Ukraine, $160 million caused by the FX, the difference between euro and dollar. And remember, a significant portion of our business is euro-denominated. So that clearly, as that revenue declines plus we also calculate about $60 million of supply chain challenges that would linger until the end of the year. The impact of that plus the excess inventory that we built, that's what takes us to the breakeven cash flow guidance that we've given. So where can we see areas of improvement and these are the areas where I'm very focused on. One, we need to add velocity to that $1.3 billion backlog that we have. The faster we can convert that, the better off of we will be.

Does that prepay option help on the cash?

The prepay option obviously helps on the cash. The other thing that we're doing as we continue to believe that the environment will remain a little volatile, we're also taking some cost actions that some of -- in 3 buckets, one, people, reducing redundancies. The other one is real estate. We're changing our real estate footprint. I think that we would all agree that the way we work and operate has changed. So now we're stuck with probably a little bit too much real estate than what we actually need. And then we have some very large outsourcing contracts for our back office that we're going to be renegotiating. So the combination of those things, I think, is going to -- what's going to help us achieve the guidance and get the model back on track to what we believe the model can actually deliver.

Yes. So getting the model back on track, so you've had many kind of add-backs to EBITDA. When are we going to get somewhat of a cleaner EBITDA where restructuring is somewhat nonrecurring?

Well, so in Q1, we had no restructuring. So I guess we kind of fixed that for a quarter. But in reality, our model will get back on track by 2024, where we should expect it to be a much cleaner model.

Okay. And then let's talk about the debt stack and where we stand, what are the sequence of events that kind of need to take place? And where are we there?

Yes. So around debt stack, and I'll be very brief around this. So we're -- our plans are to -- our plan initially at the beginning of the year was to refinance the entirety of our debt stack. Obviously, the world has changed a little bit, so we're looking at different alternatives. The first thing that we're looking and we have -- and we asked covenant relief from our banking group that was granted to us. So now we have nothing -- we could probably wait until early next year to take any action. However, we're not waiting. So one of the things that we're looking at is, first, changing our cash-based revolver into an ABL. There's a lot of support from our banking group. Again, if you think of the -- of an ABL and what the collateral would be against that, it's the orders placed by banks and top-tier retailers and receivables are from those same banks. So there's a lot of support for us to move in that direction, which would probably be also better for us cost wise. As we do that, we need to get consent from our debt holders, in order for the ABL to be placed. So we're working on those options and we've hired advisers that are helping us kind of manage that situation. And well, all the conversations that we've had both with equity and debt holders, everybody is very supportive of finding the best possible solution to change the structure of the capital in the company.

And as you kind of look at the overall portfolio, what are some things you can do to maybe monetize some assets of the portfolio if needed?

So as I always say, I like the composition of our company very much. So clearly, all the assets that we have, I like the composition that we have in the company. I like that we're in banking, that we're in retail that we're in hardware, software and services. I think that, that provides a lot of resiliency. So what we need to do is just make sure we're operating with maximum rigor to monetize all the assets in its current form. But obviously, as I always say, we will always be open to if something were to change, we are always looking at what else we could be doing to improve the value to our shareholders.

Got it. So we have a couple more minutes for some questions from the audience. I have some here that I'll start with, but if anyone wants to ask anything as well. But -- so let's talk about the -- there's a question here about access to labor. How much of a constraint is it on growth? I mean it is somewhat of a...

Yes. So I'll be very brief. So the biggest constraint that we have labor wise is probably in North America. We've seen that stabilize. There's still pockets where it's challenging to get labor, particularly as our field technicians. But this is more of a North America or U.S. problem, U.S. and Canada problem than a global problem. So in the rest of the markets, access to labor remains available to us.

Okay. So just on the manufacturing and delivery update in China, is China improving kind of restarting from post zero lockdown?

Yes. So clearly, China opened up the various ports in the past couple of weeks. So we're seeing improved flow there. But remember, the supply chain is a game where once you fix one node, then you migrate the problem to the next one. So we will clearly see the congestion in China ease up, but then that we need to start working on where is the next congestion going to happen to start being proactive in managing that ahead of time.

Got you. And then this last question here is what gives you your confidence, visibility in delivering this year's kind of revised guidance?

Well, I would say that gives me confidence that we're going to do it. But what gives me confidence in reality, Paul, is we have a very strong order backlog. We have customers that are very adamant of us speeding up deliveries to them. So we have strong backlog. We have customer demand. So it is in our hands to work through the supply and logistic issues to be able to deliver that revenue to customers.

And just on the confidence, you acquired almost 50,000 shares recently. Just talk about confidence you have in the equity.

Well, I acquired 50,000 shares. So I -- No, I strongly believe in our model. And it's not just me, it's a whole management team in the company. Jeff Rutherford, our CFO, Jon Leiken, our General Counsel, Christine, we all -- we're very active as well as our board members acquiring stock because we believe that there's significant value in our company, and we just need to get through some of these disruptions to our model, and then we will start realizing the value that we know that our company has.

Okay. Great. I appreciate your time today and call it out a wrap. Thanks.

Thank you. Thank you, everyone.