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Edited Transcript of DBD earnings conference call or presentation 29-Oct-19 12:30pm GMT

Q3 2019 Diebold Nixdorf Inc Earnings Call

NORTH CANTON Oct 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Diebold Nixdorf Inc earnings conference call or presentation Tuesday, October 29, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* 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

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Conference Call Participants

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* Ishfaque Ahmed Faruk

Sidoti & Company, LLC - Analyst

* Justin Laurence Bergner

G. Research, LLC - VP

* Kartik Mehta

Northcoast Research Partners, LLC - Executive MD, Director of Research, Principal & Equity Research Analyst

* Matt J. Summerville

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

* Robert Jost

Invesco Ltd. - VP & Senior Loan Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Diebold Nixdorf-hosted Third Quarter 2019 Earnings Call. At this time, I would like to turn the conference over to Mr. Steve Virostek. Please go ahead, sir.

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

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Thank you, Brittany, and welcome, everyone, to Diebold Nixdorf's Third Quarter Earnings Call for 2019. Joining me today are Gerrard Schmid, President and Chief Executive Officer; and Jeff Rutherford, our Chief Financial Officer. During our prepared remarks, we will be referencing slides which can be accessed on the Investor Relations page of dieboldnixdorf.com. Later this afternoon, an audio replay of today's webcast will also be posted to the IR website.

Slide 2 of our presentation today contains a reminder that a number of our comments pertain to non-GAAP financial information, which we believe is helpful in assessing the company's performance. In the supplemental slides, we have provided schedules which reconcile each non-GAAP metric to its most directly comparable GAAP metric.

On Slide 3, we inform all participants that certain comments may be characterized as forward-looking statements and that there are a 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 with that, I'll hand the call back to Gerrard.

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

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Thank you, Steve. Good morning, and thanks to everyone for joining our call. When we laid out our DN Now transformation changes at the beginning of 2019, our efforts were focused primarily on sustainable improvements in cash flow and operating profits, while enabling a greater focus on our customers and solutions. This quarter, and on a year-to-date basis, I am very encouraged by the year-over-year improvements we have delivered to both gross margins and cash flow as key measures of our progress. As you can see on Slide 3, we are driving sustainable improvements to operational efficiency, while evolving our solution set and strengthening our financial position by executing our DN Now plans.

As a critical business product to banks around the world and the largest European retailers, our connected commerce solutions enable millions of daily transactions spanning more than 100 countries. Our industry leadership and geographic breadth has many benefits, and it also exposes the company to changes in the macroeconomic landscape. For example, this year, we've faced numerous revenue foreign-exchange headwinds as the U.S. dollar has strengthened against other foreign currencies. On a year-to-date basis, currency fluctuations have effectively reduced the company's revenue by approximately $130 million or just over 4% versus the prior year. We are also observing early signs of weakening customer confidence in future economic activity in some markets, most notably in Europe. That being said, we are confident in the competitiveness of our solutions, whether it be through our newly launched DN Series, our AllConnect Data Engine-enabled services offering, our retail self-checkout solutions, dynamic software or our managed services capabilities.

On Slide 4, I'll speak to third quarter highlights. Starting with orders, in our Retail segment, we experienced solid growth for self-checkout and kiosk solutions, including a new contract for self-service kiosks integration and monitoring software at 60 Dave & Buster's restaurants. Point-of-sale orders, however, declined after several quarters of growth, as certain European customers reacted to slowing economic activity. We also saw certain contracts extend into later quarters.

For Eurasia Banking, quarters decreased in constant currency as a few deals with customers in EMEA slipped into future periods. Business conditions in the U.K. remain challenging, and we maintain our focus on profitable contracts in Asia.

Americas Banking reported relatively flat orders versus the prior year, as we were up against a strong prior year period comparison in Latin America. We continue to see solid activity from regional banks in the U.S. with some easing of demand from larger banks in the U.S., as they complete their Windows 10 upgrades. During the quarter, we secured a sizable new software contract to transform the debit platform at a top 10 U.S. financial institution.

Turning to our revenue performance in the quarter. Total revenue was essentially unchanged versus 1 year ago after accounting for approximately 300 basis points of foreign currency headwinds and 100 basis points from our portfolio-shaping actions. We believe this lens provides an important perspective on our revenue performance, and this approach will become even more meaningful as we expect to complete a few transactions over the next few months.

Non-GAAP gross profit for the third quarter improved $29 million or 12% versus the prior year, primarily as a result of our DN Now initiatives and despite $7 million of foreign currency headwinds. Our non-GAAP gross margin increased approximately 350 basis points versus the prior year to 25.5%, which represented the best performance on this key metric since our combination. We delivered solid margin expansion across all 3 segments with contributions from services and products and software. Our progress is indicative of changes we're driving in the way that we conduct business through our DN Now initiatives.

Adjusted EBITDA for the third quarter increased by $5 million year-over-year or 5%, as higher SG&A expenses offset some of the gross profit benefits. Our cash flow performance was excellent. DN generated $65 million of positive free cash flow in the third quarter, which is ahead of our expectations. When compared with the prior year, our free cash flow improved by $100 million -- $190 million for the quarter due to more efficient collections, inventory management, payables as well as higher operating profits.

On a year-to-date basis, our execution in these areas drove a free cash flow improvement of $390 million over 2018. We believe this points to a sustainable change in operating behaviors from the broader team at DN.

Slide 5 is a familiar chart, which summarizes our key DN Now initiatives and our objective to deliver $400 million of gross savings through 2021. The transition to our new operating model is virtually complete, and we have good line of sight towards approximately $100 million of gross savings for 2019 as well as cumulative savings of $130 million of savings through 2020. We've also made good progress in simplifying our ATM product portfolio and optimizing our manufacturing footprint. Our focus has shifted to realizing the benefits from a successful launch of our next-generation banking solution, the DN Series.

Our Services Modernization Plan continues to generate positive results, which can be seen in our non-GAAP gross service margin, which expanded by 350 basis points versus the prior year period to 26.9% in the quarter.

We continue to execute on our company-wide initiative to reduce selling, general and administrative expenses by about $150 million through 2021. This includes a number of actions which will rightsize our support structure, improve internal processes, enhance our productivity and better leverage our global scale. And while SG&A ticked up in the quarter, we see that as an exception to a long-term trend.

DN remains focused on improving our net working capital, and we are on track to meet and possibly exceed our 2019 goal of $100 million year-on-year improvement. For the third quarter, we reduced net working capital as a percent of trailing 12-month revenue to 15.6% from 24% in the prior year period. As we close out 2019 and build our operating plans for 2020, we are developing additional productivity initiatives, which will be shared on future earnings calls.

Slide 6 updates the progress we're making on simplifying our product portfolio. The efficiency gains from our manufacturing initiatives contributed to our non-GAAP product gross margins of 20.8% in the quarter, which increased 320 basis points versus the year ago period. One of our biggest drivers of competitive differentiation is the DN Series, our next-generation banking platform. While we're still in the early stages of our launch, I can tell you that the initial customer reception has been very positive, as they see clear benefits from a more modular and upgradable design, which includes our next-generation cash recycling technology, advanced sensor technology and connectivity to the DN AllConnect Data Engine, which will increase uptime and offer better customer experience, greater node capacity and industry-leading security features in a smaller footprint, and increased options for personalization and branding.

DN Series offers a compelling value proposition, driven by a vastly better customer experience. We're pleased to announce that we have initiated the DN Series certification process with more than 150 customers across 30 countries. We are encouraged by this early progress, including interest from customers that have not historically, purchased hardware from DN.

On Slide 7, we've provided an update of our Services Modernization Plan. We accelerated the replacement of older hardware and software in the quarter, have now upgraded more than 100,000 touch points. This activity delivers a performance benefit for our customers and a financial benefit to the company from reducing the volume of service calls and spare parts. Our key performance indicators across the services business are tracking to plan. During the third quarter, we continue to maintain a services renewal rate above 95% and our contract base of ATMs is stable at approximately 621,000 units. Our key financial metric is the gross services margin, which increased 350 basis points year-over-year, reaching 26.9% in the third quarter. This is the fifth consecutive quarter of year-on-year service margin expansion, and all 3 segments contributed to our success. These results and continued engagement from our services team is very encouraging and underpins our confidence in delivering target gross margin of 28% to 29% by 2021.

On Slide 8, I'll speak to our initiatives for further reducing our selling, general and administrative expenses. Within the finance organization, we continue to lay the groundwork for centralizing our accounting processes, making greater use of shared services and increasing automation. Year-to-date savings are approaching $5 million from streamlining and outsourcing certain finance functions, and we're tracking to substantially greater savings over the next few quarters. In our sales organization, we are realigning support resources with market opportunities, and in doing so we've been able to reduce our expenses. We also continue to bring strong discipline to the procurement activities associated with external spend. For the 9 months ended September 30, we have reduced third-party spend by approximately $19 million.

With respect to our real estate holdings, the company continues to consolidate underutilized space, including half-dozen offices in the Americas, and we've streamlined our presence in China. Year-to-date, we've either closed or rightsized more than 30 locations, and we're on track to reduce our office square footage by about 9% by year end.

In the third quarter, our progress on reducing our non-GAAP SG&A expense was masked by about $12 million of unfavorable items listed on this slide, and Jeff will provide further color during his remarks.

Looking to the fourth quarter, we expect progress from our DN Now initiatives as well as the easing of unfavorable items, which will result in a noticeable sequential improvement in our SG&A expenses. Looking at the past 12 months, non-GAAP SG&A as a percent of revenue edged lower by 20 basis points to 15.6%, and we remain confident in our ability to reduce SG&A to (sic) [as] a percent of revenue, and we are reiterating our target of 13% to 14%.

In conclusion, our third quarter results demonstrate that the company continues to drive substantial improvements to our profitability and cash flow, even as revenue was relatively the same as the prior year period. Based upon our year-to-date results, currency headwinds and our current order book, we are revising our outlook to about $4.4 billion of revenue for 2019. We are also narrowing our outlook for adjusted EBITDA of $400 million to $410 million in light of higher compensation expenses based on our stronger-than-expected cash flow performance. On the strength of our working capital achievements, we are raising our free cash flow outlook from a modest positive to a range of $70 million to $100 million. And now I'll hand the call over to Jeff.

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

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Thank you, Gerrard, and good morning, everyone. Our third quarter results demonstrate that Diebold Nixdorf is strengthening its financial position by improving our operating efficiencies, generating positive cash flow and reducing our debt leverage ratio.

Slide 9 contains the revenue comparison for our 3 segments and business lines, both as reported and on a constant-currency basis, excluding the impact of our portfolio-shaping actions. Total revenue of $1.08 billion was essentially unchanged year-over-year after factoring in the effects of foreign currency and our portfolio-shaping activities. The foreign currency headwind was approximately 300 basis points during the quarter, or about $26 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. Our portfolio-shaping actions accounted for another percentage point, for about $13 million of year-on-year variance.

Using the same lines for the segments, DN delivered revenue growth of approximately 6% from the Americas, while Eurasia Banking declined 2% and Retail declined 6%. Looking at revenue trends within our 3 business lines, software and products revenue increased 3%, primarily due to growth in the Americas. The 2% decline in services revenue is largely attributable to lower installation activity in Europe and maintenance in the United States.

Moving to Slide 10, I'll discuss the financial highlights for all 3 segments. Starting with Eurasia Banking. Revenue decreased 2% after adjusting for currency and our portfolio-shaping actions to $405 million during the third quarter. Large installation activity in Europe impacted services revenue, although product revenue increased primarily due to customers in EMEA. Software revenue was relatively flat year-over-year. Non-GAAP operating profit decreased modestly from $44 million last year to $42 million in the third quarter as benefits of our DN Now initiatives were masked by the items Gerrard mentioned during his comments about SG&A expense.

In the Americas Banking segment, revenue increased 6% to $404 million, led by product and software growth. We continue to benefit from Windows 10 refresh activity in North America and cash recycler shipment growth in Latin America. Service revenue in the quarter declined modestly year-on-year, due primarily to lower maintenance revenue in the United States, partially offset by growth in Mexico and Brazil. Operating profit increased from $2 million 1 year ago to $29 million in the quarter, due to product revenue coupled with significant expansion of our product and services gross margins by our DN Now initiatives.

Our Retail segment experienced lower-than-expected product volumes as well as lower gross margin stemming from a less favorable mix of products and this is primarily -- the primary driver of the year-on-year revenue and gross profit declines. Additionally, operating profit of $13 million was impacted by slightly higher operating expense versus the prior year.

On Slide 11, we provide a year-over-year comparison of our non-GAAP profit metrics. Gross profit increased $29 million year-over-year, primarily as a result of our DN Now productivity gains and cost reductions and included foreign currency headwinds of approximately $7 million. Non-GAAP gross margin increased approximately 350 basis points to 25.5%, which is our best performance since the combination of Diebold and Nixdorf in 2016 and reflects our focus on sustainably improving our profitability.

As mentioned during Gerard's comments, SG&A expense was unfavorable in the quarter, as a few items are masking the progress of our DN Now initiatives. On a year-over-year basis, these items include: $14 million of annual incentive compensation, which includes lower expense in the third quarter of 2018 due to the company's performance -- underperformance in 2018 and a higher-than-expected expense in the third quarter of 2019 due to much better cash flow performance; $7 million from mark-to-market accounting on our legacy Wincor option program, which is tied to the value of the DN stock price; and approximately $4 million invested in HR tools and other items to enable our DN Now transformation.

In the fourth quarter, we expect to report a strong sequential improvement in SG&A expense, as we realize savings from our DN Now initiatives. Operating profit in the quarter increased $10 million versus the prior year period to $66 million, and the operating margin expanded by 120 basis points to 6.2%. Correspondingly, adjusted EBITDA rose $5 million year-over-year to $98 million and adjusted EBITDA margin expanded by 80 basis points to 9.1%. Expenses in both the current and prior year period include the reclassification of approximately $2 million from cost of service to selling expense. This change pertains to a handful of software employees who have been involved in presales activities.

Moving to Slide 12, I am pleased to discuss our free cash flow accomplishments, which continue to exceed our expectations. For the third quarter, we generated $65 million free cash flow, which translates to a $190 million improvement versus the prior year period. Unlevered free cash flow of $102 million for the quarter was $209 million better year-on-year.

These strong gains can be attributed to clear management focus, better governance and sustainable process enhancements for harvesting net working capital. As a percentage of revenue net working capital decreased from 24% to 15.6% year-over-year. I'd like to recognize the hard work and dedication of dozens of segment and finance leaders for their tremendous performance in collections, inventory management and payrolls management.

Our cash generation during third quarter is even more impressive when you consider that interest and debt payments increased by approximately $20 million versus the prior year. Lower integration payments in the quarter offset higher cash restructuring outflows. I'm gratified by the company's sustained improvements to cash flow. Over the past 12 months, we generated $227 million of free cash flow, which was better by approximately $390 million versus the comparable period. Over the same time period, unlevered cash flow improved by approximately $480 million to approximately $413 million. Based on these results, we have clearly engineered a cultural change in the way DN employees think about and manage cash.

On Slide 13, we've provided our liquidity and leverage highlights as of the end of September. Our liquidity of $680 million includes nearly $300 million of cash plus available credit. So the company has sufficient liquidity to meet its seasonal cash flow needs, invest in R&D and fund the DN Now transformation program. At the end of the third quarter, the company's net debt was approximately $1.85 billion and our leverage ratio was approximately 4.7x for the trailing 12-month period. The chart on this page illustrates our steady progress in reducing our leverage ratio through EBITDA growth and debt reductions over the past 5 quarters.

Subsequent to the quarter, we used approximately $19 million in net proceeds from the sale of our equity stake in Kony to reduce our secured debt. Since our last earnings call, our debt maturity schedule changed as shown on the right of this slide. We successfully accessed the capital markets by amending and extending the vast majority of our revolving credit facility and our Term Loan A from December 2020 to April of 2022. This extension provides ample time to deliver significant value creation from our DN Now transformation. We are pleased to receive strong support from our lenders and demand for the Term Loan A was oversubscribed. We priced our refinancing at low end of the proposed range and total debt was unchanged as a result of this event.

I want to extend a thank you to all of our lenders for their confidence in our company. Additionally, during the quarter, we've brought on a new treasurer, Zeeshan Naqvi, to lead our capital market and cash management activities. Zeeshan joins the company from Moody's, global credit rating agency, and is already making a difference. During the quarter, we entered into interest rate swaps for approximately $500 million of floating rate debt. We opportunistically reduced our interest rate risk and we expect to save approximately $2 million per year from this action. I'm also pleased to announce that Jim Barna has joined Diebold Nixdorf as our Chief Accounting Officer. Jim has a robust background in global accounting and we'll leverage his experience to drive our own finance transformation.

On Slide 14, we update our outlook for 2019 and the key drivers. We now expect to generate revenue of approximately $4.4 billion, which reflects our significant currency headwind as well as changes in the Retail environment. Our outlook for adjusted EBITDA is now $400 million to $410 million and includes an additional $10 million of incentive compensation, which was triggered by our better-than-expected cash flow. For the year, we continue to expect DN Now savings of $175 million, partially offset by about $65 million of inflation and normalized compensation, net of expected benefits from divestitures as well as approximately $25 million of nonrecurring benefits which occurred in 2018.

Our free cash flow outlook for 2019 has improved from a modest positive to a range of $70 million to $100 million. We're expecting the key components of free cash flow to include at least $100 million of cash generated from net working capital, approximately $185 million payment of interest expense, approximately $115 million for DN Now restructuring payments and transformation expenses, and approximately $50 million of capital expenditures, $50 million of cash taxes and $20 million of other cash uses.

Based on our strong year-to-date performance on net working capital and the lower levels of receivables and inventory and the performance of accounts payable, our opportunity to generate cash flow in the fourth quarter of 2019 has been reduced versus prior years. Our cash flow outlook and the aforementioned balance sheet actions should enable us to end 2019 with a leverage ratio in the mid-4s. It also should be noted that approximately 50% of our 2019 free cash flow will be used to pay down secured debt.

It is our practice to provide formal guidance for the next year when we report fourth quarter results in February, however, I would like to provide a few comments about what to expect in 2020. First, with the completion of certain portfolio-shaping actions, DN's annual revenue is likely to be reduced by approximately $100 million. Next, our current backlog, coupled with moderating customer confidence in certain markets, described by Gerrard, points to modestly lower revenue year-on-year. Our DN Now initiatives are expected to deliver gross savings of at least $100 million, however, we also expect some offsets such as lower revenue volume, wage and fuel inflation, certification cost for our DN Series and certain other investments needed to support our transformation. With respect to free cash flow, we expect a positive year-on-year contribution from adjusted EBITDA growth and modestly lower restructuring expenses. And now I'll hand the call back to the operator to begin the Q&A period.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ishfaque Faruk with Sidoti & Company.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [2]

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Jeff and Gerrard, my first question is, could you give us a sense for how the pilots for the DN Now -- the DN Series ATMs has been so far? And it looks like it's going pretty well, you guys are undergoing certification in 150 countries -- in 150 banks, excuse me.

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

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Yes. We've been -- as I said in my remarks, we've been very, very pleased with customer receptivity to our DN Series. We have them installed in production in a number of banks and in the 150 banks that we made reference to in our prepared remarks, they're going through the normal certification process that's required before one can actually move them into production. So I'd say at this stage, we've been extremely pleased with the demand for these machines. I will obviously remind everyone that the certification process for each given bank can take a period of 9 to 12 months. So there's still a period ahead of us before you'll start to see large numbers in production. But the early indicators are extremely positive.

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Ishfaque Ahmed Faruk, Sidoti & Company, LLC - Analyst [4]

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Okay. And maybe one more for Jeff. Jeff, you said that you expect slightly lower, modest decline in revenue next year. Is that something to do with the length of the certification process or like some of the FX headwinds you guys mentioned earlier?

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [5]

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It's not due to certification. It's more to the expected FX headwinds and the activities in the markets that Gerrard spoke to earlier on the call.

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Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [6]

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And so specifically, it's both FX as well as some softening of demand in Retail that we're seeing in Europe given some economic contraction in that market.

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Operator [7]

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Our next question comes from Kartik Mehta with Northcoast Research.

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Kartik Mehta, Northcoast Research Partners, LLC - Executive MD, Director of Research, Principal & Equity Research Analyst [8]

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Jeff and Gerrard -- Gerrard, you talked a little bit and so did you, Jeff, about some weakening in Europe. And I'm wondering, is that already having an impact on your orders on the ATM side? Or is it still strictly Retail-related? And are you just anticipating that to continue now into 2020 if it hasn't impacted ATM's demand yet?

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Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [9]

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Kartik, to date, it's been primarily on the Retail front and we -- depending on what happens economic, you would probably expect that to continue through 2020. On the banking side, the only thing we noticed was a handful of deals extend from this quarter into future quarters. It's not yet clear that those are necessarily tied to changes in economic conditions, but we obviously are mindful that, that may unfold. But to date we haven't seen any impact there.

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Kartik Mehta, Northcoast Research Partners, LLC - Executive MD, Director of Research, Principal & Equity Research Analyst [10]

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And then I think in the slide presentation you talked about Latin America slowing a little bit. And I'm wondering, is that any specific countries? Is that Brazil, since that's the largest market for you? Or other countries in Latin America that are maybe being impacted?

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Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [11]

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Yes, Kartik. I don't believe we actually said that Latin America was slowing down. There have been some tough comps in certain countries, but we continue to see very active activity across Latin America.

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Kartik Mehta, Northcoast Research Partners, LLC - Executive MD, Director of Research, Principal & Equity Research Analyst [12]

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And then just finally, Jeff, you gave some indications on 2020. Obviously, you're anticipating a revenue decline year-over-year. Maybe what percentage of the decline do you think is FX-related and maybe what is what you're anticipating from business conditions? And then I think, Jeff, you said, of the DN Now savings, a portion of it would be offset because of higher SG&A costs. And now there is -- so just a little bit more color on those 2 would be great.

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [13]

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Yes. I think we've covered down on and I just -- Kartik, just to be clear, your question's about 2020, right? So we're not giving guidance yet on 2020. What we're talking about is, we expect FX headwinds in 2020. And we expect that Retail will be weakening in Europe in 2020.

As far as the DN Now initiatives, we said we expect them to be $100 million. But we're going to still experience some level of inflation when we get to 2020 that will offset that. And we're also looking at what investments we're going to need to make that may have P&L effect, but will have long-term growth. And we're not ready at this point in time to release that. But certainly our expectation is that from an expansion in gross margin and reduction in expenses -- and we're at the forefront of some major changes in SG&A expenses that are coming through -- we expect EBITDA to be up year-over-year. But we haven't given guidance on it yet.

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Operator [14]

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Our next question comes from Matt Summerville with D.A. Davidson.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [15]

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I want to be clear on the anticipated debt paydown. So at the midpoint of your free cash range, $85 million, you're saying half of that will be used to reduce debt in addition to what sounded like $19 million in net proceeds from Kony, that also went to reducing debt. Are my numbers correct there, please?

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [16]

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Yes. That's correct.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [17]

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Okay. And then maybe Gerrard, could you please compare and contrast kind of the readiness of U.S. FIs this cycle, as it pertains to kind of the Windows 10 side of things versus maybe the prior cycle? Just trying to get a feel for sort of how much is left in the tank? And then I also have a follow-up related to the DN Series. Are you seeing customers delay purchases of current generation terminals in favor of opting for the next-gen DN Series?

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Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [18]

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Matt, so as it relates to the U.S. market, I think I'll break it into 2 different tranches. We continue to see very good order activity from the regional banks, and we continue to anticipate that, that will extend well through 2020. When I take a look at the large U.S. banks, a number of those have started to taper off their Win 10 upgrade cycles through the back end of 2019. So don't necessarily anticipate that much buying activity from them, as we look into 2020, beyond their normal refresh activity. So I break it into a tale of 2 different stories. As it relates to the DN Series, no, we haven't seen any evidence of any material nature of banks delaying current buying patterns. Now and again, there's one-offs here and there, but when you look at the overall portfolio, we still have a good mix of banks buying our existing fleet of machines plus those starting to run certification processes with DN Series.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [19]

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And then may be just as a follow-up, Jeff, with respect to kind of the going forward flow-through, as it relates to the $400 million in gross savings, is there a number you would maybe triangulate us on as we think about that for 2020 and 2021, kind of a go-forward flow-through in that regard?

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [20]

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Yes. So again, we are not providing guidance for 2020 and '21. But it's going to be similar to what we saw in '19. We're going to have $100 million and we already said $100 million expected in 2020. But it's going to be offset by inflation and other investments. So the net dollars will probably be less than '19, but it'll be the same type of ratio.

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Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [21]

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And then, Jeff, you're also basically saying we should see further improvement in free cash in 2020. Would you care to maybe speculate kind of where you would target your net leverage ratio coming out of next year? Are we comfortable saying it should be sub-4x, maybe approaching 3.5?

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [22]

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No. No we're not going to give guidance on that today. What I would say is, though, on cash flow that you have to remember for '20 is, and I already said it, we're expecting an increase in EBITDA. We're not going to have the same level of opportunity in working capital that we have this year. And you're going to see a little bit of that effect in the fourth quarter. We've done such a good job of harvesting working capital starting in the fourth quarter of last year that it's going to become a very difficult comparable for us starting already in the fourth quarter. In fact, fourth quarter will be -- fourth quarter '19 will be hit the hardest because we had such a good collection period last year and now that's spread over time. Our processes are continuing. It's just not a onetime event.

And that goes to what I said earlier about congratulating all of the company, this is a company after relative cash flow. But -- so we are not expecting as high a harvest of working capital. We're still going to have some restructuring payments. We're moving into the heavy portion of the finance transformation, so I'm not going to get into too much depth on that because it does affect people. But it's going to be -- we're going to spend some money in the fourth quarter and the first 2 quarters of next year. So we have an expectation for free cash flow, but we're not going to provide guidance today.

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Operator [23]

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

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

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A couple of questions here. On the reduced revenue guide for 2019, how much of that $100 million relates to FX and portfolio-shaping actions versus core markets? And then looking into 2020, I just wanted to confirm that the portfolio-shaping actions are an incremental $100 million headwind versus whatever you're experiencing in 2019.

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [25]

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Yes. So in portfolio shaping, it's approximately just a little under $30 million effect on revenue. And it's going to be the same number for FX. So approximately $60 million of the effect will be for the fourth quarter.

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Justin Laurence Bergner, G. Research, LLC - VP [26]

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Okay. Great. And now 2020, it's a further $100 million year-on-year reduction in revenue from portfolio-shaping actions versus this year?

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [27]

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Yes. Yes. It will be spread throughout the year, but $100 million reduction off of where we're going to end '19.

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Justin Laurence Bergner, G. Research, LLC - VP [28]

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Okay. That's helpful. Secondly, moving to free cash flow. There was a benefit on cash taxes and other in your guide that I guess was $10 million and $20 million, respectively. Are those sort of onetime benefits or are those benefits going to persist as we look into 2020? Because I know you've sort of commented in the past about some sort of lingering free cash flow headwinds from taxes and other?

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [29]

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Yes. And Gerrard is smiling at me because he knows that I love to have the questions about taxes, right? Now I can go on forever and bore you guys to death, but -- but here's the deal. There are some onetime deals in '19. We had a refund and we've had some payments on some other prior periods. But it's going to net out that we're going to be less. We're going to be $10 million favorable than what we've thought coming into '19. Going forward, we're -- the way we're structure is -- and this is going to be more than you want to know. We're structured as, we're manufacturing in Germany and United States, they are also our tax principals. They are selling all the product to the distribution subsidiaries. And our problem from a structure perspective is that all of our capital costs are in the principals and we're making too much money in the distribution subsidiaries. So we have to balance that out. When we balance that out, right, our cash taxes will go down. So we are still anticipating a favorable movement in cash taxes as we move into 2020.

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Justin Laurence Bergner, G. Research, LLC - VP [30]

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Okay. I'll follow up more on these issues offline because this all seems a little complicated. But lastly, sort of big picture. If you might be able to comment a little bit more on sort of the weak European service revenue performance or Eurasia service revenue performance in the quarter. I mean, it was weaker installation against better product revenue. And I guess on the Eurasia side, any benefit from sort of Win 10 tailwinds sort of coming overseas as you look into 2020?

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Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [31]

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Yes. Justin, in the quarter, in Eurasia, we saw lower total implementation services activity, which is usually a project-based activity wrapped around various services activities. There was just less of it in the quarter. I wouldn't read too much into that. In terms of Win 10, I know that in prior quarters, we had started to comment on some early signs that we might've been seeing in some markets. That appears to be somewhat more muted this quarter. And our suspicion is that in light of the evolving economic outlook for Europe that we may see that spread out rather than have the same sustained momentum we saw come out of the Americas, so I'd say we continue to have a watching view on that topic.

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Operator [32]

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(Operator Instructions) Our next question comes from Rob Jost with Invesco.

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Robert Jost, Invesco Ltd. - VP & Senior Loan Analyst [33]

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I just had a couple. I wanted to go back to the services and on slide -- I want to say Slide 7, your renewal rates take a step down in the third quarter and this is on a trailing 12-month basis. So talk please about what's happening with that 200 basis points reduction there? Because that looks like there is -- is that a contract loss? Or is it project-based? Any commentary would be helpful.

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

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Yes. That really ties, Rob, to a modest reduction in units in the Americas, specifically related to one contract. And once again, these are very, very high renewal rates, and we're not seeing any structural change in our ability to retain our business. But in the quarter, there was one Americas contract that accounted for most of that reduction.

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Robert Jost, Invesco Ltd. - VP & Senior Loan Analyst [35]

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I see, okay. And then on SG&A, I know you called out a few kind of unusual onetime type expenses. But -- I'm just wondering about the glide path here, you're targeting, kind of, 13.5% 2021. Are you thinking about it as a kind of 100 basis reduction going into '20 and then another 100 basis points into '21? Or -- I'm just trying to figure out the glide path here.

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Jeffrey L. Rutherford, Diebold Nixdorf, Incorporated - Senior VP & CFO [36]

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It's not going to be linear, right? Because it's going to be that some stuff -- movements in some of the things we're doing. And what we're looking at is understanding what I said before about -- I'll give you some insight on some of the things we're looking at. When you look at the business, we are -- with Germany and the U.S. being principals, you have full level service requirements there. And when you get to distribution subsidiaries, it can be SG&A, and particularly G&A, can be handled more on a regional basis. And those are the types of things we're looking at. That will not be linear. It's going to be step. So we'll provide some additional insight into that when we provide guidance. But we are committed to the $100 million of targeted reduction, but some of that is going to be cost of goods sold also in 2020.

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Operator [37]

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

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Justin Laurence Bergner, G. Research, LLC - VP [38]

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In light of the Kony sale, which I guess I wasn't aware that, that asset sat in your books. Are there other similar stock holdings or assets in your portfolio that can be monetized, of sort of that equity holding nature?

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

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You know, Justin, there is very few assets similar to our equity investment in Kony. There are other actions underway related to certain historical joint ventures, where we would be looking to move from a majority position to a much lower position, which certainly will have some positive benefits. But straight up equity transactions similar to Kony, those are relatively limited for us. That being said, as you would have heard from Jeff when he talked about the impact of $100 million of revenue declines in 2020 due to divestitures, obviously when you do the math, that would suggest that we have a number that we expect to close in the not-too-distant future, and obviously once we do, we will provide an update on those.

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Justin Laurence Bergner, G. Research, LLC - VP [40]

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Okay. Great. Were there any meaningful proceeds from asset sales or portfolio shaping in the current quarter? Or are you speaking more about prospective additional disposals or exits that would relate to that line of revenue?

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Gerrard B. Schmid, Diebold Nixdorf, Incorporated - President, CEO & Director [41]

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Yes. Other than Kony, we haven't had anything material in the last 90 days.

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Stephen A. Virostek, Diebold Nixdorf, Incorporated - VP of IR [42]

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Great. Well, I want to thank everyone for joining our call today, and appreciate your time. And if you have follow-up questions, please give us a call here at Investor Relations. Have a great day.

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Operator [43]

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Thank you, everyone. This concludes today's teleconference. You may now disconnect.