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Edited Transcript of DBD earnings conference call or presentation 25-Jul-19 12:30pm GMT

Q2 2019 Diebold Nixdorf Inc Earnings Call

NORTH CANTON Jul 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Diebold Nixdorf Inc earnings conference call or presentation Thursday, July 25, 2019 at 12:30:00pm GMT

TEXT version of Transcript


Corporate Participants


* Gerrard B. Schmid

Diebold Nixdorf, Incorporated - President, CEO & Director

* Jeffrey L. Rutherford

Diebold Nixdorf, Incorporated - Senior VP & CFO

* Stephen A. Virostek

Diebold Nixdorf, Incorporated - VP of IR


Conference Call Participants


* Jeangul Chung

JP Morgan Chase & Co, Research Division - Analyst

* Josh J. Beck

KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst

* Justin Laurence Bergner

G. Research, LLC - VP

* Matt J. Summerville

D.A. Davidson & Co., Research Division - MD & Senior Analyst

* Robert Jost

Invesco Ltd. - VP & Senior Loan Analyst




Operator [1]


Ladies and gentlemen, good day, and welcome to the Diebold Nixdorf hosted second quarter 2019 earnings conference call. At this time, I would like to turn the conference over to Mr. Steve Virostek. Please go ahead, sir.


Stephen A. Virostek, Diebold Nixdorf, Incorporated - VP of IR [2]


Thank you, David, and welcome, everyone, to Diebold Nixdorf's Second Quarter Earnings Call for 2019.

Speakers on today's call also include Gerrard Schmid, President and Chief Executive Officer; and Jeff Rutherford, Chief Financial Officer.

For your benefit, we've posted slides to accompany our prepared remarks today. You may access those slides at the Investor Relations page on dieboldnixdorf.com. Later this afternoon, audio replay of today's webcast will also be posted to the IR website.

Slide 1 contains a reminder that today's comments will include non-GAAP financial information, which we believe is helpful in assessing the company's performance. We have reconciled each non-GAAP metric to its most directly comparable GAAP metric in the supplemental schedules of our slides.

Over on Slide 2. We inform our participants that certain comments may be characterized as forward-looking statements, and that there are a number of risks -- number of factors that could cause actual results to differ materially from these statements. You may find additional information on these risk factors in the company's SEC filings.

Also please keep in mind that forward-looking information is current as of today, and subsequent events may render this information out of date.

And now I'll hand the call over to Gerrard.


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [3]


Good morning, everyone, and thanks for joining our presentation.

I'm pleased to report that our second quarter results demonstrate strong improvements to profitability and cash flow, which are directly linked to our execution of the DN Now transformation initiatives. First half progress provides us with the confidence to improve our 2019 outlook today.

Before I comment on our results, I'd like to highlight one of the more exciting developments - the launch of our next-generation banking solutions - branded as DN Series, which we announced about a month ago. We believe the DN Series further extends our position as the market leader by enabling advanced capabilities, which benefit consumers and support financial institutions' assets to transform their branch environment. Initial feedback from customers has been very strong on the capabilities and performance of the DN Series.

Key highlights of our second quarter are contained on Slide 3. Total orders during the quarter increased to 5% in constant currency versus one year ago. In the Americas Banking segment, orders were stable versus the prior year and included

More than $90 million for Windows 10-capable machines,

A contract to upgrade BBVA Bancomer's ATM fleet with 750 cash recyclers and over 100 cash dispensers in Mexico;

A product and software contract at a regional bank located in the Midwest U.S. for full function ATMs as well as our DN Vynamic Connection Point and security licenses;

A new account win at a credit union in the U.S. operated by a Fortune 50 IT services company for ATMs Vynamic Connection Point software and a 3-year managed services contract;

A $17 million win at Banco Itau Unibanco to transform their branches and increase automation via cash recyclers, full function ATMs and maintenance services; and

A win with another top Brazilian financial institution for 300 cash recyclers and a 2-year maintenance services contract.

For Eurasia Banking, orders increased versus the prior year after adjusting for currency. We experienced strength from our customers in Europe, the Middle East and Africa. In Asia Pacific, orders improved to a modest decline as we began to anniversary our decision to exercise greater bidding discipline and focus on more profitable market segments.

Noteworthy contracts in Eurasia Banking included:

A new frame agreement at Commerzbank in Germany for several hundred ATMs and a multiyear software and services maintenance contract,

A new multiyear contract with a German financial institution valued at $5 million to provide cash terminals and ATM as a service,

A contract with a top 3 bank in Saudi Arabia valued at more than $10 million to take the next step in their branch transformation journey with cash recyclers, dispensers, kiosks and Connection Point software;

A new contract with the Development Bank of Singapore for about 150 cash recyclers, self-service monitoring and maintenance;

An $8 million win at the third largest financial institution in Kazakhstan for more than 300 cash recyclers, more than 100 cash dispensers and about 40 drive-up ATMs; and

Wins at 3 leading banks in Africa valued at $15 million for cash recyclers, cash dispensers and software, two of these banks are new accounts for Diebold Nixdorf.

Switching over to retail orders. We delivered meaningful constant currency growth during the second quarter, fueled by the strength of our self-checkout solutions in EMEA and Asia where we experienced record shipments in self-checkout.

During the quarter, DN signed a $7 million contract with U.K.-based Co-Op for more than 400 self-checkout terminals and related services. We also secured a $12 million agreement to deploy comprehensive point-of-sale solutions at a leading supermarket chain based in Germany. And in addition, we signed a $3 million contract to deploy next-generation point-of-sale software to more than 1,200 fuel and convenience stores in Germany. Our solutions feature greater security measures being mandated by the government as well as enhancements to the customer experience.

To summarize current market conditions, demand for our banking solutions is solid in nearly all regions. In retail, we've seen growing demand for our self-checkout solutions coupled with an easing of demand for point-of-sale solutions.

Moving on to our revenue performance in the quarter. Total revenue increased by 8% in constant currency versus one year ago excluding approximately 4 percentage points of foreign currency headwinds or $41 million.

Growing product revenue enabled all 3 segments to deliver constant currency growth, 14% for Americas Banking, 4% in Eurasia Banking and 6% from Retail.

Non-GAAP gross profit improved by $54 million versus the prior year led by significant gross margin expansion across all segments and business lines as well as a contribution from growing product revenue.

Adjusted EBITDA for the second quarter increased by 162% or $66 million year-over-year against an easy comparison as we realized both productivity enhancements and expense reductions from our DN Now initiatives.

I am particularly pleased with our free cash flow performance. Improved profitability, along with strong net working capital management, enabled DN to reduce its use of cash in the second quarter by $109 million versus the prior year.

For the first half of 2019, unlevered cash flow was a positive $13 million, which is approximately $246 million better than last year. These achievements also had the effect of reducing our leverage ratio from 5.7x on March 31st to 5x on June 30th - even though we paid $87 million during the second quarter to squeeze out the remaining minority shareholders of Diebold Nixdorf AG.

These financial results illustrate the commitment, focus and the cohesion of our management team. I'm encouraged by the way our team has responded over the past year.

On Slide 4, we provide a timeline of our key DN Now initiatives. Most of you have seen the slide before and it reiterates our goal of generating $400 million of gross savings through the year 2021 while simplifying our operations and enabling our employees to increase their focus on our customers.

We are nearly complete with the first initiative, streamlining our operating model, in which we have reduced management layers and clarified roles across the organization. As a result, we have very good visibility towards approximately $100 million in gross savings in 2019 and cumulative savings of $130 million of savings through 2020.

Second, we are targeting about $50 million of savings from simplifying our ATM product portfolio and optimizing our manufacturing footprint. During the quarter, we took a big step forward by announcing a new product family, the DN Series.

Our third initiative is to generate at least $70 million of savings from our Services Modernization Plan through the year 2021. We've executed well on this initiative as demonstrated by the 490 basis points year-over-year gains to our non-GAAP gross service margins.

Our fourth initiative is to reduce selling, general and administrative expenses by about $150 million through 2021. I'll provide a bit more context on these initiatives on subsequent slides, but will add that halfway through the year we are tracking to our plan.

We're also focused on improving our net working capital by approximately $100 million in 2019. We are tracking well towards this goal. In the second quarter, the company reduced net working capital as a percent of trailing 12 months revenue to 17.7% from 22.8% in the prior year period. Our second quarter performance marks the third consecutive quarter in which this metric has improved by more than 250 basis points year-over-year.

Finally, we continue to work on divesting noncore assets amounting to about 5% of annual revenue. During the second quarter, we divested our cash-in-transit business for banking customers in Europe and we continued to action several other projects, which will likely reach resolution through the end of 2019 or the early 2020.

Moving to Slide 5, I'll discuss the progress being made on simplifying our product portfolio. Those of you who participated in prior calls know that we reduced the number of ATM configurations we were selling in 2018, and we're targeting a further reduction of 30% for 2019. This enabled the company to streamline our supply chain and we have really benefited from a reduction in lead times.

We continue to optimize our manufacturing footprint by consolidating subscale facilities and shifting production to lower-cost locations. Those actions, along with our bidding discipline, are driving meaningful product gross margin expansion for the quarter and year-to-date.

Looking to the future. We are enthusiastic about delivering the next generation of banking solutions, which we've branded the DN Series. This product family is the culmination of meaningful investments in consumer research, design, engineering resources and tooling.

Key benefits and features of the DN Series include:

improving ATM availability and performance using advanced sensor technology, machine learning and connectivity to the DN AllConnect engine;

facilitating automated cash management via next-generation cash recycling technology; integrating the Vynamic software suite, which includes integration with mobile devices and support for biometrics;

providing a clear modular upgrade path for our customers as their needs to evolve; simplifying and streamlining our supply chain and offering a longer-term path to substantially standardizing our platforms globally;

increasing note capacity, processing power and improved security in a smaller footprint.

The DN Series also offers increased flexibility for personalization and branding. We have received strong positive feedback from 18 different customers who are piloting these terminals in 13 countries.

On Slide 6, we've provided an update of our Services Modernization Plan. Since launching this initiative in the third quarter of 2018, we have upgraded more than 20,000 customer touch points, which were generating a higher volume of service calls and required more spare parts.

Our actions are driving a performance benefit to our customers and financial benefits to DN. We are automating incident reporting and response by connecting more terminals to the DN AllConnect Data Engine. This solution gathers intelligence from a number of sensors in the ATM and uploads performance information to the cloud where the data is analyzed. Based on activity to date, we believe the AllConnect Data Engine could enable the company to reduce call rates by approximately 20%.

As a result of these initiatives, we are improving service levels in many countries. Additionally, we are rolling out value-based pricing policies linked to the age of the ATMs.

Our key performance indicators across the services business are tracking well. During the second quarter, we continued to maintain a services renewal rate solidly above our 95% target. Our contract base of ATMs declined modestly to approximately 622,000 as we exit low-margin accounts.

Our key financial metric is the gross services margin, which increased 480 -- 490 basis points year-over-year, reaching 26% in the second quarter. We saw strong year-over-year gross margin gains in Germany, United Kingdom, Italy, Spain, Brazil, Mexico and several other countries. This is the fourth consecutive quarter of year-on-year service margin expansion, and our Q2 margin was the second highest level since Diebold and Nixdorf combined. Our results, coupled with a strong engagement from our services team, is highly encouraging and provides the confidence to increase our 2021 target to a range of 28% to 29% gross margins.

On Slide 7, I'll describe our progress to further reduce our selling, general and administrative expenses. In our finance organization, we continue to lay the groundwork for centralizing our accounting processes making greater use of shared services and increasing automation.

Our information technology leaders signed a new agreement during the quarter to deploy new cloud-based solutions, which will upgrade a number of our fragmented legacy systems. We've also reduced spend on low-value discretionary IT projects and legacy applications.

Using analytics, we have identified significant savings opportunities from consolidating and reducing the company spend with third-parties. About eighty leaders within the company have ownership of this initiative, and we are methodically tracking our progress. Our focus is yielding results as we reduced third-party spend by about $60 million in the last 6 months with meaningful reductions in logistics, temporary labor and consulting services.

Additionally, we continued to consolidate our real estate footprint. During the second quarter, we made progress in Asia by closing offices in Sydney and Bangkok.

On the bottom of the slide, you can see the steady improvements in SG&A, both in absolute dollars and as a percent of revenue over a trailing 12-month period. The chart shows that we've brought down our non-GAAP SG&A expense by about $40 million versus this time last year, which equates to nearly a full percentage point of annual revenue. Our progress and our plans give us confidence in further SG&A reductions, and we're maintaining our target of 13% to 14% revenue for 2021.

In summary, our second quarter results demonstrate solid execution from the leadership team and good alignment on our priorities. Based upon our year-to-date performance, we are raising our outlook to the high end of our prior ranges for revenue and adjusted EBITDA. We are also increasing our free cash flow outlook to a modest positive, which Jeff will detail in a few minutes.

And now I'll hand the call over to Jeff.


Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [4]


Thank you, Gerrard, and good morning, everyone. During the second quarter, we made substantial progress towards value creation as displayed by our second quarter results. That progress today gives us the confidence to raise our outlook to 2019.

For my prepared remarks today, I will center on the non-GAAP metrics, unless otherwise noted.

On Slide 8, we've provided a year-over-year revenue comparison for our 3 segments and business lines, both as-reported and on a constant currency basis.

Collectively, foreign currencies were a headwind to revenue of approximately 4 percentage points during the quarter or about $41 million versus the prior year, primarily due to the U.S. dollar strengthening against the euro, and to a lesser extent, against the Brazilian real and the British pound.

I'll speak to the currency-adjusted growth rates, unless otherwise noted, as it provide a more meaningful comparison.

Total revenue increased 8% in constant currency during the quarter. Factoring in our previously disclosed divestitures, revenue growth would have been about a point higher versus the prior year. DN delivered revenue gains of 14% in Americas Banking, 6% for Retail and 4% for Eurasia Banking.

With respect to our business lines, product revenue increased 25% in constant currency, fueled by growth in Banking and Retail. The decline in service revenue of 1% is largely attributable to the divestiture of our cash-in-transit business and very modest reductions in Banking.

Software revenue was down 3% versus the prior period where virtually all of the decline is stemming from the divestiture of a European project management services business.

On Slide 9. We're showing the financial highlights for all 3 segments. Starting with the Eurasia Banking, revenue increased 4% in constant currency to $430 million during the second quarter due primarily to strong product growth from customers in Europe, the Middle East and Africa. Services revenue was down slightly due to higher -- or due to lower contract revenue and a divestiture in Europe. Software revenue was down slightly due to -- primarily to the previously mentioned divestiture.

Non-GAAP operating profit increased from $18 million last year to $39 million in the current quarter as we delivered higher gross margins for services, products and software and reduced our operating expense. Virtually all of these improvements can be attributed to our DN Now initiatives, which were partially offset by modest headwinds from inflation of $3 million and foreign currency of $2 million when compared with the prior year.

For Americas Banking segment, revenue increased 14% in constant currency to $420 million, led by strong product growth from Windows 10 upgrades, continued demand for cash recyclers and the resolution of supply chain issues, which impacted second quarter 2018 results. Service revenue in the quarter declined modestly year-on-year due primarily to a slightly lower contract base.

Operating profit increased from a loss of $3 million one year ago to $33 million in the quarter due to the following factors: product revenue growth coupled with significant product margin expansion resulting from favorable mix of cash recyclers and lower freight costs versus the prior year, gross service margin expansion from our Services Modernization Plan and favorable comparison resulting from a onetime expense of approximately $6 million in the year ago period, the lower operating expenses resulting from our DN Now initiatives.

Our Retail segment generated revenue growth of 6% in constant currency to $300 million in the second quarter with solid contributions from products and modest contributions from services and software. We are growing Retail revenue in both EMEA and Asia.

Operating profit increased from $6 million to $16 million, due to a combination of product revenue growth as well as higher services and software margins. Currency and inflation provided modest offset to operating profit versus the prior year.

We provide -- on Slide 10, we provide a year-over-year comparison of our profit metrics. non-GAAP gross profit increased $54 million year-over-year due primarily to the DN Now productivity gains and cost reductions, but also as a result of higher service and delivery costs recorded in the second quarter of 2018, which did not recur. Foreign currency headwinds were approximately $8 million versus the prior year.

Non-GAAP gross margin increased approximately 390 basis points to 24.4%, which is our best performance since the third quarter of 2017.

Product gross margin exceeded 20% for the second consecutive quarter and reflects a mix benefit as well as the value of our highly automated and robotic plant in Paderborn. Just as a side note that our plant in Paderborn is a critical asset to our operating model, and they've done a great job -- and continue to do a great job.

As mentioned during the segment level comments, DN Now initiatives were the primary driver of lower operating expenses. A $14 million reduction versus the prior year includes about $3 million of increased expense from a legacy Wincor stock option plan.

On the bottom half of the slide, we illustrate the terrific progress we've made to increase profitability. Operating profit increased $69 million during the quarter to $74 million, and operating margin increased 590 basis points to 6.4%.

Adjusted EBITDA increased by $66 million to $107 million while the adjusted EBITDA margin expanded by 560 basis points to 9.3%.

These results reflect good execution of our DN Now initiatives, product revenue growth as well as higher service and delivery costs incurred in the prior year period, which did not recur.

Moving to Slide 11. We summarized our actions in progress on harvesting net working capital. With respect to receivables, we are centralizing our governance and improving our processes with regular account reviews in past due accounts.

These actions are producing favorable results. Our collections increased 7% during the second quarter when compared to the prior year period. And I have to say that the big piece of this is the coordination we're getting between our segment groups and our financial groups, and they've done a great job for the company over the last 6 to 9 months -- I would have to say 9 months.

The team has revamped our inventory management program by establishing clear accountability and targets for finished goods and raw materials and spare parts. Inventory was a source of cash in the second quarter, another area where the combination of manufacturing, services and the segments have done a fabulous job of managing our inventory investment.

On the payables front, we've implemented new processes and centralized both our capital committee and our indirect spend decision-making. Our $60 million reduction in cash disbursements during the second quarter of 2019 is a key indicator of our progress. It impacts the level of our accounts payable, but certainly helps on the cash flow front.

The main takeaway is that our meaningful changes are building a sustainable net working capital process and are delivering results more quickly than we envisioned. Net working capital as a percentage of revenue declined from 22.8% in the year ago period to 17.7% in the second quarter of 2019. This is our best performance since the combination of the companies.

Slide 12 describes our improvements in free cash flow. For the second quarter, free cash used was $16 million, a decrease of $109 million versus the prior year period. The most meaningful contributions to free cash flow are strong growth in adjusted EBITDA and continued harvesting of net working capital. Lower integration payments in the quarter were essentially offset by higher restructuring payments. Interest expense was about $20 million more than the prior year period.

On an unlevered basis, the company produced positive cash flow of $34 million in the second quarter.

On a year-to-date basis, free cash use decreased by $200 million in the first half of 2019, and unlevered cash flow improved by approximately $246 million versus the prior year.

On a trailing 12-month basis, we delivered positive free cash flow of $37 million, which is a first-time accomplishment since Diebold and Nixdorf combined.

As we stated in the past, the leadership team is proactively managing our liquidity and capital structure. For the last slide of Slide 13, you'll see key liquidity metrics as of the end of December and as of the end of June.

Year-to-date, the decline in cash is primarily the result of $97 million of restricted cash paid to the Diebold Nixdorf AG minority shareholders, $88 million of free cash use and reduced borrowings on the revolver.

Our net debt is approximately $1.9 billion, which translates to a leverage ratio of approximately 5x net debt-to-trailing 12-month adjusted EBITDA. We have reduced this ratio by 0.5 turn over the past 6 months even as a nonrecurring to payment DN AG shareholders added about 0.3x to this ratio.

By executing our DN Now initiatives, the company is on a much stronger footing. At the same time, we've held a number of constructive conversations with our lenders about our business, DN Now and our outlook.

With the added benefit of favorable capital market condition, this is an opportunistic time to begin the process of amending and extending our revolving credit facility and our Term Loan A, which mature in December of 2020.

Last week, we launched private-side discussions with our banks and we are very satisfied with the commitments we have received to date. We want to publicly thank our banks for their continued support.

Today, we have scheduled a call with qualified public lenders for noon Eastern Time. Interested parties should contact our agent, JPMorgan, to request an invitation to join.

On Slide 14, we updated our outlook for 2019 and the key drivers. We now expect to generate revenue of $4.5 billion, which is the high end of our prior range and reflects a modest year-on-year decline due to currency headwinds, moderate declines in Eurasia Banking as well as modest growth in Americas Banking and Retail.

Our updated range for adjusted EBITDA is $400 million to $420 million, which is at the high end of our prior range and includes approximately $175 million of DN Now savings. Partially offsetting those savings are about $60 million of inflation and normalized compensation net of expected benefits from divestitures as well as approximately $25 million of benefits, which occurred in 2018.

Our free cash flow outlook for 2019 has improved from breakeven to a modest positive and includes the following expectations: net working capital cash flow of about $100 million, net interest expense of approximately $190 million excluding any impact from our refinancing, restructuring payments of approximately $120 million, approximately $70 million of capital expenditures, $60 million of cash taxes and $40 million of other cash uses.

While we do not provide quarterly guidance, I would like to comment on the seasonal trends in our business. Specifically, we anticipate third quarter revenue will decrease modestly on a sequential basis and adjusted EBITDA could be slightly more than our second quarter results.

During the fourth quarter, we expect both revenue and adjusted EBITDA will reach the high watermark for 2019.

Additionally, our free cash flow cadence is expected to follow normal seasonal trends and that the company will generate significant free cash flow in the fourth quarter.

And now I'll hand the call back to the operator, and we can begin our Q&A period.


Questions and Answers


Operator [1]


(Operator Instructions) And our first question will come from Matt Summerville with D.A. Davidson.


Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [2]


A couple of questions. First, I was a little surprised to the positive side of things to see your Eurasia Banking business reaccelerated here in Q2 as well as seeing decent order intake. Do you feel that this is a sustainable inflection? And can you dig a little deeper in terms of what you're seeing in the business? What's driving the turn to the upside there?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [3]


Thanks for the question. I think there are 2 drivers unfolding. As I mentioned in my prepared remarks, as it relates to Asia Pacific, it really was quite a headwind for us over the last few quarters as we adopted a more disciplined approach to pricing. And as that calendarizes and washes through, we're seeing less headwind and less impact from that in Asia.

The more positive side for us is the sequence of events unfolding in EMEA, specifically Western Europe, Middle East and Africa. We're continuing to see broad and decent demand starting to emerge from those markets, specifically around Win 10 operators.

If you think back to some of the comments I've made in prior quarters, Matt, we had signaled that we anticipated Europe to lag the Americas and we're now starting to see that growth emerge in markets like Germany, in markets like the Middle East and Africa and I think that -- those look like they're starting to take hold in a nice way.

So overall, we're feeling fairly confident around our medium-term outlook around demand from those markets, in particular.


Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [4]


And then as a follow-up, you mentioned in your prepared remarks on the services side that you're launching a sort of a different pricing strategy. Can you talk about what sort of customer feedback you've received on that strategy? And ultimately, is this -- should we view this essentially as you being able to go out with pricing power, and in fact, get better pricing?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [5]


Yes. So Matt, these are actually several initiatives that we launched a few months back and we're waiting to see what sort of feedback we're going to get from the market. And we were looking at what we consider value-based pricing tied broadly to the age of the machines and the amount of service calls that we incur by age of machine. We've seen very good market receptivity to that approach, specifically in the Americas.

In Europe, it's been a little bit more mixed depending on the different markets in which we operate, but we do see it as a net positive for us as we drive towards higher services margins. And I think that what we're trying to do and I think we've been sharing this quite openly with The Street, we've been looking to expand our services margins. And in light of the momentum that we've seen over the past 4 quarters hitting a high watermark of 26% gross margins in Q2, we are feeling confident that we're going to increase our longer-term outlook to 28% to 29% in part due to the pricing initiatives as well as other productivity initiatives that we have in flight.


Operator [6]


Our next question comes from Josh Beck with KeyBanc.


Josh J. Beck, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [7]


I know that you talked about the order growth and it looks like it accelerated nicely from Q1. Any other color you can share on things like book-to-bill or backlog and maybe how that impacts your visibility as we think about the 2021 framework you've provided on 2% to 4% growth over that period?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [8]


The first thing I'd say is that this is not an industry that has long-term visibility into order activities, so I wouldn't be in a position to give you a perspective on 2021 at this stage. So my comments are going to be more near-term focused.

As relates to backlog, I'd say our backlog tapered off modestly in the quarter, but not anything that would give us any cause for concern whatsoever. I think it's just more of a seasonal pattern that we've been working through.

And as we take a look at the large markets where we see very large dollar volume orders, our pipeline is looking very, very healthy as we look at activities through the back half of the year and into the early part of 2020.

Book-to-bill ratio is pretty consistent and broadly stable, so I don't think there's anything incremental I'd add on that comment.


Josh J. Beck, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [9]


Okay. And following up on the last highlight that you made around services gross margin and more confidentially you're kind of raising and quantifying that in the 28% to 29% range. Did also fall through to operating margin and EBITDA margin long term? Or are there other offsets when we think about the longer-term margin model?


Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [10]


No, no. Josh, when we model that out, that comes right down to EBITDA directly out of gross margin. There's nothing offsetting that.


Josh J. Beck, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [11]


Okay. And then just last question, if I could. Just on this data of Windows 10, obviously that's been, I think, a positive cycle and a nice tailwind this year. Do you feel like it's -- it has legs to it? Or maybe if you could just describe the tenor of discussions that you're having with banks in Americas or in Europe around that cycle?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [12]


Yes. Josh, I'm going to remind listeners of the broader answer I generally give on this. When we're having constant conversations with banks, the conversation seldom, if ever, is purely around Win 10 only. There are a number of demand factors driving the demand for ATMs. So what we are seeing is a very noticeable shift in banks shifting from relying on historical cash-dispensing machines towards higher IP, more expensive cash recycling machines. And the reason in terms of that particular demand is they're looking to shift more complex small business transactions from a teller to the ATM and additionally looking to use that to reduce their cash-in-transit costs. So that really is independent from Win 10 activity, but certainly as relevant to dialogue as Win 10 itself.

The other key driver we're seeing is demand from banks for higher feature function capability, especially as they look to integrate their mobile channels with their ATM channel, looking for things like cardless withdrawal transactions.

So I'd be very careful around drawing too many conclusions around Win 10 alone. I think it's much more broader demand drivers than just Win 10.

Taking a step back from everything I've just said here. That's really why we've said in our prepared remarks that as we look out over the medium term, we're feeling fairly positive about the Banking outlook given that we're seeing ongoing strength in the Americas from the regional banks, in particular, as well as in Latin America. And in Europe, we're seeing strengthening demand in a number of markets in Western Europe and the Middle East and Africa.


Operator [13]


Our next question comes from Justin Bergner with G. Research.


Justin Laurence Bergner, G. Research, LLC - VP [14]


Nice performance this quarter. Just to start, I guess I wanted to just look at the adjusted EBITDA bridge. It seems like the DN Now savings were up by $15 million. The nonrecurring benefits, which, if you could sort of explain a little more, that would be helpful, were up by $5 million and the overall midpoint was up by $20 million. So I guess it was up by -- sorry, it was up by $10 million on a steadily higher revenue base. So I was just curious what were some of the offsets to those tailwinds that might have allowed perhaps a higher adjustment to your adjusted EBITDA guide?


Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [15]


Yes. So you're asking specifically what -- one is the offset that's coming through in the migration of 2018 EBITDA to 2019. And there are some offsets in there. And what we have is when you roll that forward, there's going to be a small piece of FX and some level of inflation that's going to offset in every quarter we have. And it's not substantial, but it is in there.

The other thing that's going on in the second quarter is we have a Wincor stock option plan that gets adjusted. It's a cash plan, so it gets adjusted every quarter. And as the stock price moves positively, we get hit on the EBITDA line because that cost goes up.

Now I hope those guys make a ton of money this year between all of us, right? Because when they make a ton of money, then that means we've done extremely well for our shareholders. So it's a little bit of a barometer of how we're doing to shareholders. That's one of the pieces of the offset.

But generally speaking, the only things that offset us are inflation, a little bit of FX and any of these compensation-related programs we have and that may be tied to the stock.


Justin Laurence Bergner, G. Research, LLC - VP [16]


Okay. That's just helpful. And then just the nonrecurring benefits, help me understand what they are and do they just benefit '19?


Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [17]


When we were talking about the nonrecurring benefit, that was just things that came through in '18, right, that we have an anniversary going on in the first half of this year. Some adjustments in insurance accruals, the opposite effect of what we just talked about with the stock option plan, those things occurred last year and didn't recur this year.


Justin Laurence Bergner, G. Research, LLC - VP [18]




Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [19]


We don't have any -- yes, those are 2018 items that did -- benefits that didn't recur in 2019.


Justin Laurence Bergner, G. Research, LLC - VP [20]


So the $25 million versus the $20 million is just sort of an updated look-back for those nonrecurring benefits?


Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [21]


Yes, yes, for the nonrecurring benefits of the prior year. What we do is we do -- when we model, we model on a bridge modeling basis. We pick up items from the prior year than don't recur this year, whether positive or negative. They happen to be positive from '18, negative for '19 when we rolled it forward. So we're overcoming those items to get to the $107 million of EBITDA.


Justin Laurence Bergner, G. Research, LLC - VP [22]


Okay. That's helpful. Thinking more about the general business drivers, I guess the Americas orders were flat year-on-year in the second quarter, and I was just wondering if that meant that some of the Win 10 product momentum we saw in the quarter might taper a bit? Or it's hard to know what type of order absolute number you were lapping based on the detail you've provided. So any sort of color there would be helpful.


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [23]


Yes. So Justin, I don't anticipate a tapering off of demand in the Americas. You will see for any given quarter some timing issues that unfold. For some of the larger banks in the United States, in particular, some of their refresh activity is certainly nearing the end of its maturity cycle. That being said, we still think there's a long way to go for a number of very large institutions in Latin America and we continue to see strong activity from the regional banks.

So I don't -- from where we are sitting today, we don't see it tapering off. I think it's more just an in-quarter event that we're seeing. The pipeline is looking very, very healthy at the moment.


Justin Laurence Bergner, G. Research, LLC - VP [24]


Okay. Great. And then on the service margins, that's very promising that you're able to extend or improve the gross margin outlook for Service Modernization of 28% to 29% from 27%. I guess you discussed price on a previous question. Maybe if you could just discuss what's tracking better than you anticipate on the productivity front to allow you to increase that margin, that would be helpful.


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [25]


Yes, certainly. So as I said in my prepared remarks that we are automating incident response, and really the team is doing a great job of deploying common KPIs and common processes in each market. And the deployment of these globally common processes is giving us a lot of central visibility to practices that may not be as effective as they could be in local markets. And really that awareness in shining a spotlight on the regional differences is really bringing tremendous cohesion into the different local teams and causing us to more effectively deploy best practices around measurements like the number of times a technician touches a machine each day, the number of times we roll the truck successfully the first time. Those are some of the key operating metrics that we focus on driving consistency across all of our global markets and that's where we've seen the biggest -- some of the biggest lifts since the program began.


Operator [26]


Our next question comes from Paul Coster with JPMorgan.


Jeangul Chung, JP Morgan Chase & Co, Research Division - Analyst [27]


This is Paul Chung on for Coster. So just going a follow-up on services business and margin. So you had some contracts that were lost in India in 4Q kind of based on pricing and you did mention that you're exiting kind of these lower-margin contracts, and your margins are improving as a result.

So just thinking about the trade-off here. Will you continue to kind of walk away from some of these lower-margin renewals to try and drive that margin higher? Or are you willing to take some hits on margin to kind of drive the top line given that it's your higher margin segment kind of relative to products? And then as we move through the year, any kind of big renewals we should be aware about in the coming quarters?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [28]


So Paul, what I'd say is a lot of our activity around exiting lower-margin accounts was more pronounced in 2018 than it is now. I think we're seeing the tail end of those effects. And as we look out over the next few quarters, I don't expect that to be a material driver one way or the other. There might be a few small pieces, but I don't think it's material.

I think we're at a point right now where we feel we've got a very strong competitive mix. And to your point, if there is a specific market that we consider very strategic and there's a particular opportunity that we think relevant, we will evaluate that on a case-by-case basis. But we're not feeling any pressure to have to be price makers in this market. We believe we've got one of the world's better services value propositions.

In terms of the second part of your question around large contract renewals to the back end of this year, we have very little concentration exposure in our services business. We've got a large number of contracts that cycle through over a period of time. We do see a higher number of contracts that renew in the November December time frame, but nothing that we would call out as a material risk from where we sit today.


Jeangul Chung, JP Morgan Chase & Co, Research Division - Analyst [29]


Okay. And then how's been the pricing in services? Can you just kind of expand on the competitive environment there?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [30]


Yes. So as I believe I already talked about, when we look to the new contracts we're factoring in a broad conversation with our customers around their quality service expectations and we're also introducing different pricing constructs. And from my perspective, those conversations have been very constructive. We're not seeing a tremendous amount of pricing pressure in our services business. It actually would appear to be broadly stable at a global level. There might be pockets in some markets where we see a more local provider being more aggressive. But at the moment, I don't see pricing as a key consideration for our services business.


Jeangul Chung, JP Morgan Chase & Co, Research Division - Analyst [31]


Okay. And then on asset sales, are there any kind of additional kind of noncore areas you think you can monetize in the near term? Or are we mostly done there?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [32]


Yes. I think what I'd say is I'd just reiterate what I said on prior quarters. There are several processes underway, that they are in various stages of maturity, Paul. So once they are complete, we obviously will update our shareholders around those. As I said in my prepared remarks, we expect them to mature and go over the goal line through 2019 and perhaps straggling into early 2020. But we're still of the view that we're tracking towards delivering net proceeds of around about $150 million from those noncore assets. So the bulk of the uptick from those is still in front of us, not behind us.


Jeangul Chung, JP Morgan Chase & Co, Research Division - Analyst [33]


Okay. And then my last question is on free cash. 2Q was very nice and then I did see your inventory days come down materially. So if you could kind of expand on the drivers of that improvement there and if we should kind of expect any inventory build ahead seasonally strong 4Q.

And then just thinking about this seasonality, I know you mentioned that 4Q would be your kind of strongest as it has been in the past, but is it going to be kind of a similar pronounced step-up from 3Q to 4Q?


Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [34]


Sure. The -- from an inventory perspective, and I believe we've said this on prior quarters, but it's worth saying because the teams have done such a great job in managing inventory. So we've divided inventory up into its component parts. The manufacturing group is responsible for raw material and WIP. The services group is responsible for spare parts. And then we divide finished goods between the segments.

And let's start with finished goods and work backwards. We only allow finished goods to be manufactured in transit for delivery or installation applicable to a specific customer order, we hold strongly to that. The segments understand that and are managing that. So when you see finished goods inventory for us, know that, that is inventory en route to be delivered to a customer for a future sale. So it's really about timing of order to fulfillment, and the segments are doing a great job of managing that.

On the spare parts perspective, it's spare parts for our services organization for use and repair and maintenance of equipment. They've done a great job of managing that on a regional basis, only having the required -- based on algorithmic logic, they only have in the required spare parts in any specific location. And as we roll out our new equipment, we'll be even more precise with that.

So both ends of that, we don't expect to see, unless we get tremendous sales revenue backlog coming, we don't expect to see significant change.

And then on the manufacturing side, the manufacturing group has done a tremendous job of managing their inventory. And as always, I'll invite anybody who has a trip to Germany to plan and come and see our plant. Our plant is tremendous. They do a great job. It's extremely efficient. It's one of the reasons we can leverage the model the way we are because we have that plant in Germany. So -- and they've done -- and just back to your question, they've done a tremendous job of managing inventory.

So I would say that our inventory performance is team-wide between these 3 groups and they've done a great job.


Operator [35]


Our final question comes from Rob Jost with Invesco.


Robert Jost, Invesco Ltd. - VP & Senior Loan Analyst [36]


Just two for me. On Slide 6 where you go over the service renewal rates, I guess I just wanted to kind of tease out, you get this target rate of greater than 95%, which is kind of below historical the last 4 quarters. Is this just a bit of conservatism here? Or is this signifying something that we should expect to be seeing down the road?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [37]


Rob, it's nothing but conservatism, right? We don't expect our renewal rates to drop to that level. We're simply making sure that our investors take away -- I mean the real message here is that we have a very, very sticky services business with exceptionally high renewal rates and that's really the only message here. There's no signaling implied in that number.


Robert Jost, Invesco Ltd. - VP & Senior Loan Analyst [38]


Okay. Great. And then in your DN Now, the new -- the product that you're launching, a couple of -- with the reference base you have, I'm not seeing some of the larger banks. So maybe if you could comment on that.

And then, secondarily, with this AllConnect engine, is this going to be another revenue stream? Or this kind of layered into the services' more of a benefit on the back end?


Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [39]


As to the latter part of your question, it's embedded in services. It will just simply enhance our ability to add greater visibility to our customers and drive greater productivity in our services business. So I don't see it as incremental revenue stream.

As it relates to your first question around DN Now, I mean there are several large brands that are piloting it. Santander and BBVA are obviously very, very large scale European banks operating both in Europe and Latin America, the same holds true for BNP Paribas out of Europe. What we can say is that for some of the large U.S. banks, they are also certifying the new machines in their labs. So I don't think you should read anything into not seeing a top 3 bank from the U.S. on this list. I wouldn't read anything into that.


Stephen A. Virostek, Diebold Nixdorf, Incorporated - VP of IR [40]


Thank you, everybody, for joining today's call. If you have follow-up questions, please give Investor Relations a call. Appreciate your time.


Operator [41]


Thank you. Ladies and gentlemen, that concludes our conference this morning. You may disconnect your phone lines, and thank you for joining us.