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

Okay. Good afternoon, everyone. Welcome to our fireside chat with Diebold Nixdorf. We're very pleased to have the company's Chief Financial Officer, Jeff Rutherford, with us today. Jeff, thanks for being here at Barclays Leveraged Finance Conference.

Sure, Jeff. Thanks for having me.

So why don't we start out with one of the key reasons for the 1Q performance weakness and the sharp reduction in your guidance. Was it worsening of supply chain challenges? Maybe talk about these challenges, how you're dealing with them, both with respect to inflation and the logistics issues, getting product installed to customer locations, et cetera?

Yes, sure. So I think it makes sense to first frame out what our manufacturing platform is. Our main facility for both retail products and high-end ATMs is in Germany. We do have a plant in Ohio. We do have a plant in Brazil for the Brazilian market. And then we have a joint venture where we're a minority interest holder in a plant in Inspur with China -- in China with Inspur that makes the low-end ATMs. So the issue that we have relative to supply chain and the length of supply chain is that we source electronic components out of China, and there's delays and excess costs to get that product into Germany or the United States. And then we've had delays in moving that finished good product from Germany into the United States. To capsulize what the issue is, is that historically, when we produce the legacy Diebold ATMs in the United States, order to installation, which is revenue recognition for us, was fewer than 90 days. Today, it's over 200 days from order, if the order's coming Germany. So that's the delay of converting backlog into revenue. The inflationary costs are multiple. The biggest portion of it is inbound and outbound freight. If you're moving product inbound from component parts from China and Germany, it's more expensive. If you're moving finished good products from Germany to United States, it's much more expensive relative to container cost and transatlantic shipment. So we've experienced both delays in product, this is our first quarter issue, conversion of backlog to revenue and also incremental inflationary costs, especially in the product category, although we do have other labor inflation and services and software.

Okay. Great. And an important part of addressing inflationary cost increases, increasing prices, but talk about what's been done to date on that front across your businesses, what other actions are planned, surcharges, et cetera, and where you've been successful raising prices and where it's been more challenging.

Yes. So we have basically 3 different products that we supply to our markets, both through banking and retailers. First is in service. We sell ATMs, we sell self-checkout units. There's a high attachment between the hardware and service contract. For service contract, inflation is mainly labor, although spare parts, there is spare parts inflation in there. Those contracts are annual renewals. Whether they're long term or 1-year contract, there's the ability to reprice and increase price based on inflation on an annual basis. We've been doing that for years because we have been experiencing wage inflation. So that's been effective in services. In software, mainly in professional services, we do sell licenses and maintenance to both retailers and banks. But we also sell professional services. Again, that's very labor-intensive and have that adjusted for pricing. The issue has become around products, the hardware. We made the decision in 2021, when we started experiencing the inflationary costs, not to reprice backlog. So we didn't open up backlog and repriced backlog. So if you look in the first quarter of '22, that decision in '21, the revenue that came through in the first quarter of '22 didn't have any price increases because our backlog right now is $1.2 billion on a normal year of product revenue of approximately $1.5 billion. So we have a significant amount of backlog. That decision not to open up backlog and to honor the original purchase order pricing resulted in the first quarter having reduced product gross margin of approximately 10% below what we would consider a reasonable margin. And coincidentally or not coincidentally, our inflation in the first quarter in products was 10%. So what we've done since then, we have a new CEO. Octavio Marquez is now CEO of the company, he came from the Global Banking Group. He was Head of the Global Banking Group for us, which is 2/3 of the business. We have opened up backlog for repricing. We're going back to customers. We're talking to customers about an option to prepay for the product, and we'll honor the pricing or we will adjust and increase pricing based upon their installation dates, or they can go out and rebid the product. So far, no one has opted to rebid the product.

Okay. And so how far along in that process are you?

Really, it's early days.

Okay. Okay. After your very successful DN Now transformation program last year to address the current performance challenges, you announced a new $150 million-plus cost reduction program you said over the next 12 to 18 months. Maybe talk a little bit about what those actions are, sort of the timing of implementation, savings and restructuring costs associated.

Yes. So Octavio coming from operations has a different lens on the company than someone from my seat or someone that comes in from outside. He's been with the company for 8 years. So he had some ideas of where we were, I have to be careful how I say this, but where we had redundant costs or we're inefficient, example would be that we have multiple sales support organization. We had one in finance. We had one in sales. We had one in pricing. They reported to different organizations. Those are the type of things that under the new organization structure we're putting in, those will be consolidated into one organization. We have under -- as everyone is aware, and all companies have this, with the new way to work, we have excess real estate. And then we have also opportunities to -- and we always have opportunities to go back and rebid out contracts, my contracts relative to shared services and so forth. We're doing all those things. We put together a comprehensive plan to accelerate those savings. A majority of it is going to be headcount. And therefore, the cost associated with that is going to be severance. We've estimated that severance costs would be approximately $75 million. We're going to look at how we can pay that out over time so we don't have a significant cash flow impact of it. That cost is already built into the model. So if we can stretch it out over a reasonable period of time, there won't be negative cash flow effect. Now we're not going to be able to do that in every country, especially some of the European countries, but that would be the plan. So it's all identified. It's coming right out of the model. There will be some costs, but we're effecting that plan as we speak.

Okay. When do you think most of the actions will be in place so you'll get to the $150 million run rate? And what -- around what have you factored into your '22 guidance in terms of the same?

Very little in '22 guidance. I think that the headcount, the FTE portion was less than $20 million of the $150 million. I think that we'll be at a full run rate 12 months from now. But we're trying -- we're looking at ways to accelerate those savings as a hedge against incremental inflation or future interruptions relative to conversion of backlog to revenue.

Got it. Okay. Shifting to your revised guidance. So of the $300 million decline in revenue guidance at the midpoint, about $160 million was from FX, $80 million from Russia, Ukraine, meaning only about [ $60 million ] from additional supply chain challenges from your last guidance. So how are you looking at -- what are you seeing and how are you looking at those supply chain improvements for the balance of the year?

Yes. So the low end of the guidance is we don't get a lot of improvement and supply chain conversion of backlog. What we need and the plan going forward is we having a lot of plan that is converting over to what we call the DN Series ATM. So DN Series ATM is the high-end ATM. A majority of them are cash recycling. Cash recycling is where a bank customer, mainly retail customers that collect cash, can go into the ATM and deposit the cash directly in the ATM. The machine puts them back into the cartridges to be issued to mainly consumers going forward. The U.S. is now adopting cash recycling. They like our technology. So that's a high demand. That's why we had 23% increase in order entry in the first quarter. But we need to make those in the United States at the plant in Canton, Ohio. North Canton, Ohio. And that will cut off some of the inflationary issues and also the conversion issues. It's much easier to move a heavy piece of equipment like an ATM on the road from North Canton, Ohio, to some place in the U.S., Canada or even Mexico than it is to ship it in a container from Germany here. So that's key to our future relative to addressing our supply chain issues. And as we go through and look at where we source product and how we source product, that is also going to be part of it.

Okay. And just on the EBITDA -- adjusted EBITDA guidance, about $115 million reduction, I think, from the 4 50 to 3 35 at the midpoint. Can you bridge that $115 million with respect to how much just directly revenues, other additional unrecovered inflation, et cetera?

Yes. Yes. It's not in SG&A and OpEx. SG&A and OpEx are going to be flat to relatively down for the year. So it's all in gross profit. If you look at $300 million of revenue for us, a targeted gross margin percentage for us is comparable to the first quarter of '21, which would be 29% to 30% gross margin. Obviously, we're not at that level this year. So it's going to be somewhere -- from a modeling purposes, use 25%. So that's $75 million of the $115 million. The balance is really the spread between inflation and pricing, so the change in the model was that we are experiencing. When we modeled for 2022, we model for the first quarter, we modeled 5% inflation, we experienced 10%. When we were looking at the back half of the year, we thought inflation was going to moderate at something in the 4% to 5% range. It's not. We're going to continue to experience inflation for the year. So if you -- so the difference is all relative to non-billable inflation.

Got it. Okay. Let's move to the main topic on investor minds, which is the debt structure and the company's refinancing options. You hired Evercore and Sullivan & Cromwell to assist with this. Maybe talk about some of the options you have as you face your '23, '24 maturities and your bank covenants as well as dealing with the secured notes.

Yes. And obviously, we've had a lot of discussion with that the last days since we [indiscernible]. First of all, we've worked with our banking partners on the revolver, and we have covenant relief through 2022. So effectively, we have it through the first quarter of 2023. And that date is significant to the banks because the revolver matures in July of '23. So that frames it up that we need to do something relative to. For the revolver of this company and based on my experience of other companies that have gone through restructuring transformation needs to be in an ABL. We have $1 billion worth of receivables and inventory, so we can certainly do an ABL. The banks are -- it's the best thing for the banks, it would be the best thing for us, less expensive and so forth. So why it hasn't been done before? I can't really explain that, but that's where we need to be, in an ABL. But the problem with the ABL is that -- with the secured, the security is [ paired too ] with the senior secured notes and Term B. So we have to deal with that. We have to deal with the fact that Term Bs mature in the fourth quarter of '23. We have to deal with the fact the unsecured mature in the second quarter of '24. So we have consign issues. We have maturity issues. We've talked to a number of debt holders in all aspects of the deck or the stack of the debt stack. And we've gotten good feedback, latest today, from investors in our debt. We need to -- we're not going to be able to do it through conventional means. I mean, when we originally issued the senior secured notes in 2020, the intention was to be at this conference to help sell a refinancing. That's not going to happen. It's going to be a negotiated refinance. The bank groups are forming. We know who they are. We've talked to them. They know us. We know them. It's going to be through discussion and negotiation as to how we end up on that.

Okay. And what's your time frame for resolution of your path? And do you -- are you seeing any initial impacts from suppliers, customers with everything that's been reported?

Well, certainly, it's going to -- we have a very sophisticated customer base. Of all the restructurings I've been involved in, it is by far the best customer group, global banks and 25 top retailers in Europe. So they know a lot. That's something we're going to have to deal with on a daily basis from a sales perspective. I have talked to customers. So -- and we're going to have the same issues with suppliers. So the sooner we have resolution, the better off everyone's going to be. And employees, too, right? So everyone who is a stakeholder in the company has invested in us resolving these issues. The groups that are forming are forming as we speak. That's good, I believe, because it helps us target who we need to talk to and resolve issues. So I'm confident that within the next -- I'm sure everybody wants to see second quarter data, but hopefully, and I know hope is not nothing, but sometime over the next 6 to 9 months, we have this result. We don't want to go into '23 and have this be an open issue.

Got it. Okay. Okay. And the groups being term loan -- representing the term loan, secured and unsecured? Or is it sort of a combo?

Well, the [ Capri ] Beach Point Group is across the capital structure, and the Gibson Group is concentrated on the Bs. And I'm not aware of any other group at this point.

Okay. Okay. Let's shift back to the businesses. You continue to show solid order volumes. Maybe talk generally about demand, or do you think there's been some acceleration of -- I know you don't have perfect visibility on this, but some acceleration of orders due to the supply chain concerns?

No, I don't think so. I think that's a long lead time and a long sales cycle. And I think the demand is in relation to our product versus anything else. We have what we would consider the best ATM in the market right now. And no one wants to buy legacy Diebold or Wincor Nixdorf ATMs anymore. They want to buy the DN Series ATMs. And even customers who weren't buying from Diebold Nixdorf have come back to get that ATM specifically. Now we've had issues obviously converting it to revenue, but the demand for that ATM is very high. On the self-checkout, self-checkout continues to grow. It's going to continue to grow in the mid-teens going forward. Our growth is greater than that. It's a multiple of that. It will be this year. We are fortunate where we are positioned with major European retailers. Certain retailers that historically have said that they would not install self-checkout units are now rolling them out globally, and we're participating in that. And we're following those retailers into the U.S. So you're going to see more of Diebold Nixdorf self-checkout units in the U.S. and certain of the European -- you can see them in IKEA now, and then there's a major European grocery chain that will be implementing them in the coming years.

Okay. And in banking, can you talk about how you're seeing demand conditions geographically, Americas, Europe, Asia?

Well, the most difficult market to get product to is our best market and highest demand. The U.S. market is very good for us right now. The Spanish-speaking South American market remains strong. The Brazilian market remains strong. The European market is a mature market in certain pockets. But it's -- there's still a refresh cycle there. I mean, banks are still refreshing their ATM fleet. So we still see the refresh cycle. Middle East is a good market for us. And Asia Pac remains a challenge for us. That's the most competitive market and the most price-sensitive market.

Okay. And then just back on retail. You talked about the market shifting to self-checkout from point-of-sale, which Diebold's a beneficiary. Maybe talk about how you're faring competitively there in Europe, and also, how do you see the more mature point-of-sale market?

Yes. Point-of-sale continues to surprise me in that it remains at a fairly high level unit-wise. There's pricing pressures in point-of-sale. And from a unit economic perspective, it's not a good -- as good a model for us because it's low attachment to service. It's in the 30s or low 30s. Self-checkout market is very good in that normally, a retailer will take maybe 2 lanes that are point-of-sale and convert it to 4 self-checkout units. It's a higher price point. It's a high attachment to service. It's in the 90% attachment rate, if not higher. So unit economics, we'd like to see that trade from POS to self-checkout. The adoption really is the post-pandemic issue that I think many customers and many retailers have come to the conclusion that self-checkout is a much better option than a person touching your product through a point-of-sale. And I think maybe I already said that there are retailers, European retailers who said they would never put in a point-of-sales that have been now rolling them out globally. So that's something that's going to continue. And we're in a good position where we're structured. We got a big refresh cycle from a competitor of a major European grocery retailer. Our issue has been a challenge to come into the United States. Our competitor is very strong in the U.S. with U.S. retailers. We are going to be here following the European retailers, and maybe that will be -- that was one of the major assumptions for Diebold to buy Wincor Nixdorf was related to the success that Wincor Nixdorf had in European retailing and it would carry over to U.S. retailing. It hasn't. This may be the avenue for us to get into that from a self-checkout perspective following the European retailers into the U.S.

Okay. Okay. And also in services, you've been exiting some unprofitable business, some international markets. Maybe talk a little bit about the services business, renewal rates across markets and your ability to increase prices there.

So the way to look at -- we're not a real complicated model. If you look at the banking model, and everybody who's in this business has the same model, is that it's about installed base. And we have 1/3 of the installed units globally, excluding China, I think. And then that installed base is spread among 120-plus countries where we have -- we own the distribution and the service in about half of those, 60 countries. So in 60 countries, we sell through our own distributors. The attachment rate is relatively high for where we have distribution. It's in the 90-plus percent range. The competitor is our customer. There are still certain banks that, for whatever reason, service their own ATMs. They buy spare products from us, they service their own. So the key to the service contract business is that installed base. We have very few -- there's very limited crossover between manufacture and service for developed markets, especially in the United States and the Americas and Europe. Where we do not fare well is where we are no longer selling ATMs, or it's a very limited market for us, so certain Asian markets where we can't compete in ATM pricing. When those contracts -- because normally, what they do, and in particular, I'm talking about India, is there's a -- you sell the product, you give a long-term warranty, and then you can charge them service for 4 or 5 years. When those contracts terminate and you try to renew those contracts, they're not willing to pay the price relative to -- we don't want to service old ATMs and lose money. That's not a good business, right? So we continually lose those type of contracts. But right now, we're seeing strong demand for our product, which is increasing the installed base. And as I say, with that installed base comes incremental services. So we're working through some of these issues in Asia and other countries. But right now, in the U.S., we have, as I said, 23% increase in order entry. So we're holding our own relative to U.S. installed base.

And what about providing other services for banks as a service and other outsourcing? Like you said, the banks, my understanding was part of this more midsized banks are doing with the large banks not yet. But what are you -- how much of an opportunity you see there for the company?

It's a good opportunity for us. You look at the model, you look at the Diebold Nixdorf model, and we have -- I look at our assets being one asset that we have is the installed base. There are, as I said, almost -- not in China, but in the rest of the world, 1/3 of the ATMs are Diebold Nixdorf or a combination of Diebold and Wincor Nixdorf. So that's a significant asset. The other asset is that service contract base, and it all depends on that installed base. But that service group that we have, that global service organization, there aren't many country -- companies anymore that have global service organization. And so that is a key asset for us. Off of our installed base and contract base, we can continue to provide to banks or retailers for that matter, incremental services, whether that's security, monitoring, video teller, any number of things, all the way up through higher levels of software. So that's a key growth mechanism for us in banking. And it's true in retailing, too. But then, even that service group is what it was seen by the EV charging companies as something that they have approached us and said, "Why don't you expand into EV charging servicing?" Many of our customers, whether fuel and convenience or retailers, especially in Europe, have contracted with us to service those charging stations that they're connected to. And we work with the manufacturing. Now I don't know where that's going to end up. I don't think anybody -- anybody tells you where they know EV charging is going to end up, they -- and they're right, you can make a lot of money. If they're wrong, you can probably lose a lot of money. But EV charging is still in development. We do the -- we are servicing a number of charging stations in Europe. We do it in time and materials because no one really knows what the failure rate is going to be on EV charging. That's under development. But I will say this, with the high-voltage DC charging stations, you're going to want somebody with training to work on those. AC, less so. So there's something there. I just can't tell you at this point in time how big it's going to be. But certainly, there's horizontal and vertical opportunities within service to continue to grow the service revenue stack within the company.

All right. Why don't we see if there are any questions from the audience? You can raise your hand, and we'll bring the mic over.

Spoke to sophistication of the investor base. I guess I'd just be curious on the heels of the takedown in outlook and a softer Q1, any concerns around firmness of the backlog with the European customer base and just ability to continue to win business? You talked about kind of following that customer into the U.S. with the capital structure maybe relative to last year coming more into question than it was. I guess what's your level of confidence in terms of the stickiness of that backlog and that customer base and winning business going forward?

Yes. Yes. So we're in a -- our customers are not only sophisticated, they're critical, right? So during the pandemic, both banks and many of the retailers were critical suppliers to economies and they stayed open. we are critical from a service perspective and from a technology perspective. Yes, are we concerned? Always. But we always are concerned about our backlog and -- but we are also confident because of that critical nature of the model that it's a sustainable model. In our discussions with our debt investors, we're going to come through with a resolution. I mean, my message to customers would be I think everybody understands that this is a viable model that's going through some issues right now relative to inflation and supply chain. But that's why they are so positive about coming to a resolution of these issues. So I'm confident we're going to come to a resolution. I can't tell you exactly when. But everybody that I've talked to that is party to these, even from a decision-making perspective, is ready to move on and get it resolved and help the company achieve the intrinsic value that it is destined to be. I mean, that's why I bought stock. That's why Octavio bought stock. That's why Board members bought stock. We're committed to the capital structure. We're committed to all of our stakeholders. So -- and we continue to be. So we would ask customers to help support us in that. And we've got some very good relationships with customer base. So they've -- so far, they've been all supportive.

Another question over here.

Kind of building on what you were just stating there, you've shown confidence in the business, you kind of listed out these macroeconomic factors that have been limiting you and the CEO of kind of executing your vision for the company. And it seems that a lot of these, it seems that the capital structure is one of those things that's fairly inhibiting your ability to be nimble and kind of reactive at situations at hand. I know you mentioned that you think that this should be resolved in the next 6 to 9 months. Do you have like your vision as CFO of what that resolution looks like? What is the Diebold 2.0 capital structure in the company look like?

Yes. Yes. So for me, this is an inherited capital structure. And I've said this before, and I don't need -- I'm not saying this to offend anybody. But none of us in the room would have created this capital structure. I've made a fairly decent living because people make mistakes with capital structures over the years. So what I'm talking about with the resolution of the current issue is not the long-term capital structure. We're not going to get to the long-term capital structure in the next 6 to 9 months. The way the company is constructed, I could talk for days about these things. As people bought Wincor Nixdorf, they created 2 tax principles: the United States and Germany, and they share intellectual property between those 2 entities. Now if you wanted to pick the 2 most aggressive taxing authorities in the world, I'm not sure you could do a better job than picking the United States and Germany to share intellectual property. So we're stuck with that structure, right, which means you have to align your capital structure, especially for deductible interest between those 2 entities because basically, they are the parents of all of the distribution subs globally. Through transfer pricing, you're bringing income back to Germany and United States. And what has happened to us is they put all the majority of the deductible interest in the United States, and we have none -- we have very low efficiency relative to interest from a tax perspective. So we will not get to the correct capital structure for this company in the next 9 -- 6 to 9 months. What we're doing is getting to a place where we have the ability to address the model issues we're experiencing right now. We've come out and said for '24, we're confirming that -- we're not a huge growth company. We're 2% to 4%. But certainly, the model is capable of generating greater than 13% EBITDA margin and certainly capable of converting that EBITDA at a 50% rate of free cash flow. That's where this model should be. That's why I have confidence in the model. But we need to get there, then we can go back and to correct the capital structure issues because they're not going to get corrected over the next 9 months. What we're doing over the next 6 to 9 months is addressing the current issues associated with the near-term maturities so that the model can get back to where it needs to.

[ Want some ]?

Yes. I don't think the capital markets will be open to a point where we could move incremental debt into Europe, which is really what we need to do. The -- we've got enough on our plate, Jeff, with these issues. You're just putting additional pressure on me. Now you want me to correct the capital structure. I think ultimately, it's a highly leveraged model. It needs to get EBITDA to where it should be, and you can do the math on what I just said relative to targets. You get there, then you're going to have some options relative to addressing the capital structure.

Got it. I think we're out of time here. Go ahead.

All right. Just a quick follow-up on that [indiscernible].

Long-term capital structure. Capital structure is an immediate issue right now, believe me. What I would say right now from a management perspective is we are open to the discussions with our capital providers and working on a resolution of the issue associated with the near-term maturity. And I don't have a resolution right now because this is real time. But what I will say is, including the debt investors we've talked to today, recognizing what the potential is for the model that we've gotten very positive responses from debt investors thus far.

All right. With that, great. Jeff, thanks so much for being here at the conference.

Thanks very much.

And for taking all the questions during a very busy and challenging time. Thank you very much.

Thanks.