Diebold Nixdorf Incorporated Common stock

Hello and welcome to the Diebold Nixdorf Inc. second quarter 2021 earnings call. My name is Emma and I'll be operating the call today. If you wish to ask a question at the end of the presentation, please press star followed by one on your telephone keypad. If you change your mind, please press star followed by two to cancel your request. I'll now hand over to Steve Veristek, Vice President, Investor Relations. Please go ahead, Steve.

Thank you, Emma, and welcome everyone to Diebold-Mixdorf's second quarter earnings call for 2021. Joining me on today's call are Gerard Schmidt, President and Chief Executive Officer, and Jeff Rutherford, Chief Financial Officer. To accompany our prepared remarks, we have uploaded slides to the investor relations page of Diebold-Mixdorf.com. Our remarks are being recorded today and cannot be reused without the permission from the company. Later this afternoon, we will post a replay of this webcast to the IR website. On slide two, we have a reminder that today's comments will include non-GAAP financial information, which we believe is helpful in assessing the company's performance. Reconciliation schedules for each non-GAAP metric can be located in the supplemental schedules of our slides, as well as in the tables of today's earnings. On slide three, I will remind all our participants that certain comments made today will be forward-looking and that there are a number of risk factors which could cause actual results to differ materially from these statements. Additional information on these factors can be found in the company's STC files. Participants should be mindful that our forward-looking information is current as of today, and subsequent events may render this information to be out of date. And now I'll hand the call over to Gerard.

Good morning, everyone, and thanks for joining us today for another update. The company's transformed business model continued to perform on track during the second quarter as customer demand for our solutions drove strong product order growth. We're extremely pleased with the value that our customers are seeing in our propositions across hardware, services, and software. While the demand environment is strong, we're operating in a more complex and inflationary supply environment that had a modest impact on our banking business late in the quarter. Since we expect these conditions will continue, we're adjusting our 2021 outlook for profit and cash flow. Slide three highlights how we're leveraging our competitive differentiation to gain market share and grow our business. During the quarter, we delivered 6% revenue growth, spearheaded by a retail segment that grew 38% versus the prior year period. Product orders accelerated this quarter, increasing 40% versus the prior year and reaching a four-year high. Our success was broad-based, with strong growth across all three segments. and our backlog increased by approximately 20% versus the prior year period. In our banking business, demand for our next-generation DN Series ATM was strong and accounted for over 70% of all orders. I am pleased with the broad-based customer adoption of DN Series. We expanded our global business partnership with Santander Group to deliver customer innovation and operating efficiencies with more than 3,000 new ATMs, including DN series, and maintenance services in the U.S., Brazil, Mexico, Spain, Argentina, and Chile. Additionally, in the United States, we displaced a contractor at both a top 10 bank and a top 25 bank with orders for nearly 700 DN series terminals. We also booked two sizable contracts with National Bank of Egypt and Egypt National Post valued at nearly 27 million dollars for dn series dynamic software licenses and maintenance in indonesia we want contracts to refresh more than 2 200 legacy atms with dn series and our dynamic security software at a large government-owned bank in brazil we displaced a competitor with an order for more than 500 cash recyclers These examples clearly point to improving market share for Diebold Nextoff as customers recognize the distinctive value of BN series to their digital agendas. We also experienced an increase of ATMs connected to our AllConnect data engine as the number of connected machines increased more than 25% sequentially to over 90,000 during the quarter. Using advanced cloud computing and machine learning algorithms, we are remotely identifying root causes and are being more prescriptive with our response. This is a critical enabler of reducing the number of service calls, increasing our effectiveness, and reducing costs. By 2023, we expect the operational efficiencies from widespread ACDUs will increase gross service margins to the 32% to 33% range. Our retail business continued its very strong performance, led by our self-checkout products. During the quarter, we reached agreement to replace a competitor's self-checkout solutions at a multinational clothing and home product retailer based in the UK. And we're excited by the opportunity to extend our solutions to nearly 1,000 stores. We also signed an initial award at a discount apparel and household product retailer to furnish more than 400 self-checkout devices and maintenance services across Spain and Austria. And in Sweden, we booked a contract valued at nearly $4 million for a large multinational retailer to automate checkout and reduce fraud at the self-checkout counter using artificial intelligence and image recognition. Slide four contains an overview of our growth strategy, beginning with our foundational strengths in producing market-leading, high-quality products, delivering high service levels and terminal software capabilities. Across our banking and retail segments, the core model accounts for a majority of our revenue and cash flows today. Our differentiated solutions are demonstrating our ability to gain market share in these core businesses. Strength in our core offering enables high growth opportunities shown on the right of the slide. In addition to market dynamics that support long-term growth and self-checkout and our continued market leadership in cash recycling, we are pursuing a large addressable market for recurring revenue, underpinned by our ability to deliver managed services and value-add software at scale. In managed services, we continue to make progress with new contract wins in the quarter. For example, we were pleased to win a five-year managed services contract with a large Italian bank valued at $24 million. In our retail business, we secured a multi-year agreement with A.S. Watson, the world's largest international health and beauty retailer, to deliver new managed mobility software and services. 10,000 inventory devices across stores in Asia and Europe. Our partnership will accelerate AS Watson's offline plus online retail technology deployment in support of a great shopping experience and convenient checkout process. One of our software highlights in the quarter was a multi-year agreement with Nedbank for more than 4,000 DynamicView software licenses in Africa. We were selected because of our multi-vendor approach, which improves ETM availability by constantly monitoring hardware and software performance through a single user interface. With respect to our new dynamic payments offering, we are continuing to scale our debit platform at a top 10 global bank. We are processing nearly 1 million transactions each day and are expanding the capabilities from the branch and IVR channels to include all transactions across more than 15,000 ETMs over the next few months. By the end of this year, we expect to process over 5 million transactions per day. We are encouraged by our progress and will continue to invest in our advanced capabilities in order to better position the company for growth. I mentioned earlier, Band has been very strong we're experiencing a more difficult supply chain environment. Slide five highlights some examples of what we and many other technology companies are seeing. The chart on the left illustrates how global maritime shipping has become less reliable due to limited container capacity. This trend, combined with challenges in dock labor and trucking capacity, are adding operational challenges for DM, but our risk mitigation actions are currently proving effective. Strong global demand for logistics is also driving higher freight costs and increasing the need for expedited freight solutions. On the right side of slide five, we show how strong global demand for semiconductor chips is running well ahead of supply, which is extending our procurement cycles to inflationary pressure. Demand for chips has been driven by strong economic activity across multiple sectors, as well as a higher demand for electronic devices to support a global hybrid work environment. Because our products are among the most sophisticated on the market and highly digital, semiconductor chips are important components in our devices. While we have detailed plans to procure the semiconductors needed to fulfill a strong demand, Continued execution is key to the model. Additionally, broad brushed economic growth is driving up the cost of key input materials such as steel, plastics, and other electronic components. Jeff will discuss the financial implications of these factors in his comments. Before I hand the call over to Jeff, it's worth repeating that we're seeing a solid demand environment. for our differentiated hardware services and software solutions. Our main focus is managing global supply chain complexities to fulfill customer demand. Over to you, Jeff. Thank you, and good morning, everyone. I will begin on slide six with a more detailed discussion of our second quarter results and key variances versus the prior year period. Where applicable, I will also make comparisons to our first quarter results for 2021. Total revenue for the second quarter of 2021 was $944 million, an increase of over second quarter 2020 of 6%, as reported, and 2.5%, excluding a foreign currency benefit of $46 million and a $16 million impact from divested businesses. Adjusted for foreign currency and divestitures, product revenue increased 5%, Service increased 2 percent and software was relatively flat. During the quarter, approximately $30 million of revenue was delayed due to extended transport times. This primarily impacted our American banking segment and reduced total revenue growth by approximately 300 basis points. On a sequential basis, total revenue was unchanged. Non-GAAP gross profit for the second quarter was $262 million, or a decrease of approximately $2 million versus the prior year period on lower gross margins of 27.7%. Gross profit in the prior year included approximately $17 million benefit from non-recurring cost savings. Service margins declined 130 basis points versus the prior year period, which benefited from meaningful cost benefits of lower labor costs and spare parts usage during the second quarter lockdown in 2020. When compared with our expectations, second quarter service margins were in line and were slightly higher than in the first quarter of 2021. Prior gross margins were down 350 basis points versus the prior year period, primarily to $8 million of higher freight and input costs and $5 million from an unfavorable geographic mix of banking products. In addition, the aforementioned revenue delays contributed to the unfavorable mix. Software gross margins increased by 170 basis points versus the prior year period due to better contract management and resource utilization. On a sequential basis, gross profit margins decline 130 basis points in the quarter due to the unfavorable mix and higher freight costs. Operating expense of $199 million for the quarter increased $33 million versus the prior $5 million sequentially. When compared with the prior year, key variances include normalization of non-recurring SG&A costs, savings from the second quarter 2020 lockdown, of approximately $16 million. Planned investments to support the company's growth initiatives and managed services and software of approximately $8 million. And unfavorable foreign currency headwinds net of DNL cost reductions, when compared with our first quarter operating expense, increased slightly due to the timing of our growth investments. The net result was operating profit of $63 million and operating margin of 6.7% in the quarter. The same trends drove adjusted EBITDA of $86 million and adjusted EBITDA margin of 9.1% in the quarter. Starting on slide seven, I will discuss our segment highlights. Eurasia banking product order growth increased 39% versus the prior year period as we realized market share gains for my next-generation DN series APMs. Segment revenue of $326 million decreased 3% versus the prior year period, and 7% after adjusting for foreign currency benefit of $24 million and $12 million in bank from these domestic shares. We experienced lower product revenue in the Mediterranean countries, which was expected. Segment gross profit decreased to $94 million year-over-year and included foreign currency benefits of $10 million and investor impact of $4 million. Gross margin of 28.8% was down 150 basis points. A certain cost savings from the prior year did not recur as previously stated, and our revenue included a higher mix of lower margin geography. Over on slide 8, America's banking product order growth was very strong and increased 44% versus the prior year, led by market share gains via the N-series. Segment revenue decreased 6% to $313 million, primarily because of lower product revenue in North America, which included the aforementioned $30 million delay. When compared with our expectations, American banking is proportionally affected because of the physical distance between our customers and our primary manufacturing facilities for DN series ATMs, which are located in Europe and Asia. Backlog in America's banking grew 45% year-over-year. Segment gross profit at $89 million was down $18 million due to cost savings in the prior year period, which did not recur, an unfavorable geographic mix, and higher freight and input costs which I mentioned previously. The unfavorable mix reflects a larger revenue contribution from South America. Moving on to slide nine, our retail segment delivered a very strong performance. Product order growth of approximately 40% was led by our self-checkout solution. Retail revenue of $305 million increased 38%, as reported, and 28% after adjusting for a $19 million foreign currency benefit and a divestiture headwind of $1 million. Sales of our point of sale and safe checkout products both increased significantly versus the prior period. As our installed base increases, we are also generating growth from our services and software business. Retail gross profit increased 45% to $75 million due primarily to revenue growth. Gross margin expected 140 basis points reflecting increased revenue and a more favorable mix of self-checkout solutions. On slide 10, I will summarize our free cash flow performance and update our leverage and debt maturity schedules. Unlevered free cash flow use in the first half of $62 million increased versus the prior year period due to decline in EBITDA, higher inventory investment needed to support strong demand and increased safety stock, partially offset by reduction in transformation and restructuring payments. The increase was slightly higher than our expectations. The company's cash balance as of June 30th reflects seasonal cash use. The company ended the quarter with $500 million of total liquidity, including $238 million of cash in short-term investments. At the end of the quarter, the company's leverage ratio was four times more below our covenant maximum of six times. On the right side of this slide, we update our gross debt levels as of June 30th. Note, we have no material debt maturities until November of 2023. Slide 11 contains our updated outlook for 2021. Revenue of $4 to $4.1 billion is unchanged because of our strong order book and foreign currency benefits working to offset longer logistic schedules. We are modifying our adjusted EBITDA by approximately $25 million to a range of $455 to $475 million to reflect inflationary pressure on materials, and in particular, higher freight costs. Our free cash flow outlook is $120 to $140 million and includes our revised profit outlook plus investments we are making in our safety stock as global supply chains tighten. Our outlook continues to reflect a material improvement in the company's EBITDA to free cash flow conversion rate from 12% in 2020 to approximately 30% in 2021. For our concluding remarks, I'll hand the call back to Gerard. Thanks, Jeff. I'll close our call with slide 12 and two key messages. First, our growth strategy is showing strong progress, and we're experiencing solid customer demand for our digitally-enabled and differentiated solutions, with product orders up 40% and backlog increasing 20%. We're realizing broad-based market share gains with our DN series ATMs, Customer adoption of our AllConnect data engine is accelerating. We're winning business contracts and adding to our payments capabilities. Our retail business continues to deliver strong growth from self-checkout solutions and high service tax rates. Collectively, these accomplishments give us a high level of confidence in the enduring value of our solutions and our company's transformed business models. The second key message is that Diebold Nexdorf and many other technology-based companies are confronting a more challenging supply chain environment globally. Our procurement, manufacturing, and operations teams are doing exceptional work to mitigate longer lead times on same conductors and other components, prolonged transportation schedules, inflationary pressures on direct materials such as steel, plastics, and other electronics, and we will continue to work diligently with our suppliers to manage chain volatility. These conditions plus high freight costs are leading the company to adjust our 2021 outlook for profit and cash flow. However, in closing, we are pleased with the company and the team's progress in executing our strategy of providing differentiated solutions that are yielding strong water growth, as well as our ongoing efficiency gains in our business model, our improved cost discipline through our D&L program, all of which are leading to strong free cash flow growth and return on invested capital. This concludes our prepared remarks, and I'll hand the call back to the operator for our Q&A session.

If you wish to ask a question, you can do so by pressing star followed by one on your telephone keypad. If you change your mind, you can press star followed by two to cancel your request. Our first question today comes from Matt Somerville from DA Davidson. Matt, please go ahead. Your line is now open.

Thanks. Excuse me, morning. A couple questions. First, on the negative side of things, the 25 million take down, it sounds like you're instituting some actions to try and mitigate that. So I guess I'm curious maybe what that gross number looks like if the $25 million is a net number, and what are you doing in terms of mitigation, and what can you do with price capture as well to help offset some of that?

Yeah, good morning, Matt. So at a high level, let's break it down into two components, direct material inflation as well as freight inflation. On the direct material side, we continue to work very aggressively with our supplier base to look for various mitigants. I'll tell you that we can mitigate meaningful amounts of inflationary pressure on direct materials. Where it's more of a challenge for us right now is on the freight side, where just given the massive demand for sea capacity in particular, we're seeing more pressure on that front. In terms of the second part of your question, we continue to look at our entire portfolio of solutions and continue to execute on adjusting our value to our customers to reflect a clearly increasing inflation environment. Yeah, and I think I would add, Matt, a majority of our adjustments related to logistics. We have time and we have the people that are working on the inputs and the other aspects of cost increases. There's nothing we can do relatively. We're going to have to pay to get the product, especially to North America. We're going to have to pay the rate cost to do that.

Got it. Obviously, you know, orders up against, I would assume, a somewhat easy comparison relative to 2020 with that 40%. So maybe I was wondering if you could put that into context, maybe what the comparison would have looked like versus the second quarter of 19. And then relative to, I guess, you know, what kind of outgrowth do you feel you're delivering relative to underlying demand in both banks? your share gain. Thank you.

Yeah, Matt, I would say the most important comment I made in my earnings script today related to the absolute dollar value of sales activity relative to all prior periods. This was the highest level of sales activity in four years. And while the comp against last year was easier, what's more important is where we're standing relative, I think, to the past four years, and potentially higher than in any other quarter. And that was broad-based across America's banking, Eurasia banking, and retail. In all cases, each of those segments delivering roughly 40% growth, some higher, some a little bit lower, but in and around that range. And we can see clear evidence that on the banking side, we're winning market share because where we're seeing the growth coming from is from renewals in our installed base, but also net new customers at the start we bought there. ATMs elsewhere. And we're seeing that broad-based across, as I mentioned earlier on, a top 10 bank in the U.S., a top 25 bank in the U.S., as well as several examples in Eurasia, Latin America, and elsewhere. And on the retail side, while we are benefiting from a broad expansion for self-checkout adoption, we're also seeing market share takeaways. And we mentioned earlier on a Very important win for us with a large UK-based retailer with 1,000 stores where we displaced a competitor. So I think there's meaningful evidence emerging that our products are showing very, very well and adding value to our customers. Yeah, the other thing I would add to that, Matt, would be when we look at order entry for the second quarter, don't forget we had strong product revenue in the back half of 2020. And we're counting against that. And we're also seeing a very strong conversion in the DN series. So the product side of the equation is strong, which increases the issues relative to supply chain and moving logistics. But also, don't forget that market share gains contribute to services contract-based. and then and and after the three-month lag to uh service contract so so strong product unit growth results in strong services contract base appreciate that thank you guys thank you our next question comes from paul chung from jp morgan paul please go ahead

hi uh thanks for taking my questions so can you talk about the dn series win at the top 10 bank in the us you know what what kind of drove that win if you could expand on pricing there as well and how that impacted the win and you know what particular features of the dn series is you know attracting customers and displacing competition that'll follow yeah good morning paul

So the predominant capability that secured the win for that top 10 bank was not pricing. It was cash recycling capability. We're on our fourth generation technology there and feel that we are distinctively market leaders in cash recycling, given that we own our own IP in that space. That particular top 10 bank is looking to reduce their overall cash handling costs, and cash recycling gives them an important enable to do that. uh, what we signaled in this quarter was, uh, an order that was several hundred machines in scale. You know, we expect that to expand quite substantially with that top 10 bank. Uh, so I think we were very, very well positioned and that particular institution was not a historical customer, you know, a people next door. Um, and, uh, as I said, pricing was not a meaningful factor in the equation. Gotcha. And then, um, Just on gross margins, how should we think about the second half of the year, the push out of $30 million in revenues? Does that provide you some scale benefits in the second half? And any comments on seasonality of gross margins would be helpful. I assume a freight cost will weigh in the second half and maybe start to normalize maybe in 2022. Is that the right way to think about it? Yeah, I would say let's take the freight costs first, because we expect it to continue through the balance of 2021, especially after we need to get through the holidays, right? And that's what's clogging. especially from Asia. And we think it's going to last sometime through the Chinese New Year, and then we'll get some relief, and hopefully it'll normalize. But we expect it to continue through the balance of 2021. From a margin perspective, we do anticipate and based upon the strong order entry we're receiving, And we're going to see strength in product revenues in the back half of the year, even comparing to the strong back half in product revenue we had last year. And it's twofold. It's banking, and it's also the strong product growth in retail. So one of the things to remember in the back half of the year, we do have a headwind in logistics, but we have a tailwind in conversions at the end seriously. from legacy ATMs. And our expectation is that we will see a lift in back half margins off of prior margins because of that mix into self-checkout from POS and from legacy ATMs and the DN series ATMs. Okay, great. And then last question. You know, on the retail side, very nice self-checkout contribution. You know, how do we think about the seasonality for this business as well? Do you still have expectations for seasonal strength and core Q?

And, you know, your order growth was quite strong. What's the timing of that recognition for that business as well?

Thank you. Yeah, I would say it's the same as what we just talked. We continue to see strong demand. And self-checkout, I think we can say that's a little above our expectations for both POS and self-checkout. We anticipate that the self-checkout demand will continue for some time. You know, that's not only new self-checkout. We are also seeing market share gains in self-checkout. And self-checkout has the same unit equity model that ATM has. As we install self-checkouts, there's an extremely high conversion to services contract basis. So we continue to see, as we roll out self-checkout, we're seeing high 90% attachment to service contract. Okay, great. Thank you.

Thank you, Paul. Our next question today comes from Justin Bergner from G Research. Justin, please go ahead.

Good morning, Gerard. Good morning, Jeff.

Good morning, Justin.

A couple questions. The reduction in the EBITDA guide due to supply chain pressures, is that essentially all within the America's banking segment, or is there a modest piece of it that's relevant to Eurasia banking and retail?

yeah so let's break it down into a few different pieces uh justin you know you heard us say earlier on that we're seeing inflationary pressure for the direct materials as well as logistics direct materials is pretty evenly spread across all three segments however it is a smaller part of the inflationary pressure given that we have procurement levers to offset some of that now in terms of logistics costs you know we do move goods around the world But in that particular case, Eurasia, sorry, America's banking is more disproportionately hit than the other two segments because of the sea container capacity constraints between Europe and U.S. loans.

Okay, understood. Now, with respect to the shipments, I mean, you talked about having to, in some cases, pay for expedited freight. I mean, can you delay some of these shipments with customers in order to avoid having to pay for expedited freight? I mean, is that a feasible option or not so much?

Justin, as Jeff said earlier, based on everything we're hearing from the market, we anticipate the logistics constraints globally to be there likely through the Chinese New Year. So we clearly continue to work with customers to make sure we meet their needs, which is ultimately the most important part here. In some cases, we will use expedited shipping for spare parts and other activities. Clearly, we're minimizing expedited shipping for wholesale ATMs, given the weight of ATMs. But we have some flexibility to move things around, but I wouldn't say we're aiming to push things out to the Chinese media.

Okay. And then with respect to the guide on the revenue side, I mean, what can happen at this point to sort of allow you to hit the high end of the guide? I mean, is it effectively, you know, the case that the volume of shipments is a little bit lower because, you know, there's an inflationary price offset? aiding your revenue? Or just tell me, understand sort of the contours of the maintained revenue guide, if you can.

Yeah, the revenue guide, we are seeing a little bit of a tailwind from FX, and that's built into the model. But to achieve the revenue guide, and this is why we are very highly confident we can do this, it's all based on on demand and the ability to deliver that product to the customer base. And our segments do a great job of managing that process. Once we manufacture a product and Applebee, the plant, it belongs to the segment, and the segments do a wonderful job and they're incentive to do this. You have to think through that. to get those products, whether it's retail or banking, to the customer for revenue recognition. So we feel strongly. The only thing that we are really dealing with here is what we've already talked about, is the lead time and logistics, especially to the U.S., Yeah, broad-based supply chain volatility is really the only inhibitor to hitting our revenue guidance because the demand is there to support it.

Okay. Just one last one. Any sort of update on sort of your debt financing priorities given the favorable interest rate environment? I know you've talked about it on a couple of past calls.

Yeah. Yeah. Yeah, and a reminder in our – In our secured notes, there is a no-vote provision making it expensive to do anything before July of 22. Now, that's based off of interest, remaining interest to July 22. So every day that number declines. We monitor the markets. There are some things we've talked about. We will be... We will be having discussions with lenders and potential investors over the next 12 months. Timing, we're not ready to announce anything relevant to timing, but we certainly are interested in the market. We will be rebalancing, obviously, for interest purposes. You've heard me talk about that ad nauseum in prior periods. So this will be both with... U.S. banks and investors and European banks and investors. So we'll be doing the groundwork over the next 12 months. And when it's time to pull the trigger, we'll pull the trigger.

Great. Thank you. Sure.

Thank you. Our next question comes from Karthik Mehta from North Coast Research. Please go ahead.

Thank you. Hey, good morning, Gerard and Jeff. Oh, morning.

Any concerns at all that these delays could cause a loss in orders? It doesn't sound like the delays are that much, but as we move out through the year and as we get into the fourth quarter, any concern that the orders could be delayed into 2022 or you could lose them? No, Cardiff, we don't see any delays. in orders. We work very, very closely with our customers. Our customers are acutely aware of these logistics constraints. We're not in this on our own. It's impacting every other company. Look at the front page of the business section of the Wall Street Journal today talking about that as well. I don't see that as being a likely outcome unless there's a material change in circumstances. Any thoughts about potentially moving some manufacturing to the U.S., or do you think this is temporary and really no reason to kind of change where you're manufacturing or how you're manufacturing? Yeah, Karthik, we are actually well underway in terms of increasing our operational capacity in the U.S. to create some additional flexibility on our end to offset some of this pressure. And we expect those operational gains to start to support us as we move through the second half of the year. So that certainly will ease things a little bit. And that should help in 2022 as well, right, Gerard? That's right. But in 2022, we also expect the logistics scenario to be easing as well. But absolutely. And then just one last question. You know, on one of the slides, you talked about the All Connect and the success you're having there. And I'm wondering if you could talk about maybe the financial success that could have if it's already happening or, you know, right now you're still in an investment mode for that, and it will take, you know, next year or the year after to really start seeing the benefits. Yeah, Karthik, we are already – start to see some of the benefits of it. As I said in my prepared remarks, we saw a 25% growth sequentially in the connections to our engine, so we now have over 90,000 devices connected. Recall, though, that we have a installed contract base that's north of 500,000 machines, so we're still relatively early in that journey. That being said, for every device that we immediately start to see the benefits. So what you're starting to see is yeah the improvements happened somewhat slowly just given that it's machine by machine but they absolutely are starting to happen as well we're seeing that reduction in calls for each device connected and that's what gives us the confidence behind our earlier comments around long-term expansion of our services margins because we're seeing that uh already thank you very much appreciate it thank you our next question comes from anna goschko from

Hi, good morning.

Thanks very much. I have a few questions on items impacting cash flow or free cash flow. So the free cash flow guide was revised down in tandem with the EBITDAB, but there is reference to working capital use for inventory purchase as a result of the longer lead times. And is that expected to revolve a resolve in the second half? Because I would think that that would potentially continue to be a drag on pre-cash flow in the second half of the year. And then also just an update on what you're expecting for the total restructuring and other kind of DNL or kind of transformation costs for the year.

Yeah, Diana. From a transformation restructuring payments, it's still $50 million. that we anticipate spending in 21. Yeah, we're going to be up in inventory. We anticipate that mainly because we have, in certain areas, we have lifted our restrictions on on safety stock, we will have that inventory. And we more than likely, because of high demand, have more in transit inventory at year end than we would normally have. So in all, what we are modeling today is to be up somewhat in inventory. There are other traders we will pull. To offset that, to get to where we have guided relative to cash flow, we haven't gone through all the detail, but the bigger portions of it are that we're anticipating lower EBITDA for our guidance and increase in inventory working capital. By the way, that inventory working capital obviously is short-term and will reverse the in the model in 22. So increased 22. So where we're at right now is that there will be slight deterioration in EBITDA and inventory. We stuck with the $50 million of restructuring payments and all other contributors will have somewhat a net positive impact to get us to the guidance we provided.

Okay. Okay. Well, thank you for that. Sure.

Thank you. Our next question comes from Marla Bakker from Fidoti & Co. Please go ahead. Your line is open.

Thank you. So you talked earlier about one of the characteristics you see on the banking side in terms of driving some market share gains that you're experiencing being the cash recycling. capability. Can you talk a little bit about what you're seeing in terms of, you know, projected consumer, customer uptake on the video-enabled capability of the ATMs?

Good morning, Marla. So video capability is certainly an attractive feature, but it seems to be predominantly focused on the U.S. end consumer, and more notably among some of the mid-sized U.S. banks. We don't see broader adoption, quite frankly, due to different consumer preferences in Europe and other parts of the market. So certainly a less material contributor than we've been for sure recycling will be for our business. We are seeing, however, demand within the U.S. market for that product.

Okay. In terms of this call, and I think on the last call, you've talked about seeing service contracts growing in terms of the percentage of new product revenue. Can you give us a sense directionally of what you're seeing in terms of that conversion? What percent of contracts for products being written today also include the service component versus, let's say, you know, over the past two years?

Yeah, so let me start the answer that I'm sure Jeff may add to as well. So, Marla, within our banking business, in any market where we have our own direct services organization, the attach rate for services when we deploy hardware is exceptionally high. typically north of 90% with a very, very even higher recurring renewal rate for our service contract. So as Jeff was saying earlier on, part of why we're so encouraged by our very high product order growth is that ultimately, It fuels higher services revenues. And we're seeing the model be pretty consistent, and it's been pretty consistent for the past several quarters, which is what's giving us confidence as we look into future quarters that our services revenue will flow once these machines are deployed. And it's even higher in self-checkout. I mean, self-checkout is extremely high. We just reviewed that, in fact, this week.

uh point of sale is uh is lower it's a less complicated device and and uh our attachment rate for services and point of sale is somewhere around 30 percent and would you say that those those metrics are higher today than they were you know two let's say two three years ago because service the service component is just becoming a more important part of the overall business

Yeah, Marlon, we've put a lot of focus on making sure that services is one of our differentiated propositions. But as I said earlier, our tax rate in banking has generally always been in the 90s. We've seen that largely be stable, sometimes a little bit higher. As Jeff said, on the retail front, we've seen a very, very strong uptick in the tax rate on self-checkout. It's a more complicated device. not steady around 30%. So I wouldn't say broadly there's been a material change in the tax rate over the years. It differs by product, but the trend has been pretty consistent.

Okay, thank you. Thank you. Our next question comes from Matt Bryson from Wedbush Securities. Matt, please go ahead. Your line is now open.

Good morning, and thanks for taking my questions. I've got two. The backlog growth number of 20% and the order growth rate of 40%, those are both really impressive metrics. But I mean, obviously, other than retail, it's not flowing through in current revenues. When you're looking for 3% to 5% growth for the year, it's not in 2021. I guess typically I would think about that at some point. your product revenue is growing at something like that rate once you start to convert those orders into revenue. I guess, is that the right way to think about things? And what's the timing on that, assuming you see that conversion? Yeah, let me lead off first with a couple of higher level comments. So as Matt Somerville pointed out, that 40% was against a lighter 2020 comp. What's more important for us is the absolute level of orders that were strong. And we fully expect to show very strong product revenue this year as we fulfill these orders. And you'll see those flow in Q3 and Q4. Obviously, I can tell you, as Jeff said earlier on, we have a very, very high degree of confidence in our revenue guide for this year, provided we can fulfill on the orders as we work through logistics and supply chain complexities. Yeah, I agree. And as I said earlier, don't forget we've had strong, especially fourth quarter last year, we've had strong product. And because of our lead times and the relationship to your question relative to order entry and delivery, we track that by customer, by product. So we have high visibility in all those orders as to when they're going to be delivered. We get to a certain point and the segments will remind us that basically we've got all the orders we're going to have for the year. And so when we look at our order entry, we can directly relate that to revenue recognition. So we track that. We track it monthly. They track it daily. There's a high level of confidence to Gerard's point. That's why we can call out $30 million for the second quarter because we had that year for revenue recognition in the second quarter. When it didn't happen, it adjusted out of our forecast. So we track that. that conversion of order to revenue recognition very closely as we track the conversion of installed ATMs and self-checkout in the contract base. The base of this model is very unit economics oriented. Thanks. And then for a different question, Jeff, I think you mentioned on the call You shipped over to DN Series. You see some benefit on the product gross margin side, logistics and component costs notwithstanding. I guess my question there is you talked about 70% of – I think you mentioned on the call – 70% of orders are for the DN Series products.

I guess can you give us some color on what the –

the percentages in terms of shipments and when timing-wise we might expect shipment percentages to reflect that 70% order percentage.

And then lastly, just in terms of the magnitude of benefit or how we should be modeling the benefit, any color at all, in terms of how that flows into the gross margin line when you're getting closer to before we transition to the DN Series parts?

Yeah, well, we're in the middle of a very high turnover from legacy ATMs to DN Series. And the reason being, as Gerard discussed earlier, it's a better equipment, right? It's a better ATM. It's more efficient. It's very self-diagnostic, all the reasons. It's connected to all connected energy. It's very efficient, and it's more efficient to manufacture. That's what we'll say. I mean, we have competitive issues here, and we're not going to give all of our information. But let's just say that it's a better ATM that is more economical to manufacture. Yeah, and I would say, just to give a little bit more color on that, Jeff mentioned that the conversion is in flight. As you start to look through H2, you'll start to see that unfold in our product gross margins as DNCs becomes a bigger and bigger percent of what we're shipping. So that certainly forms part of our view around our confidence around our EBITDA range and our gross profit range as well.

And Matt, we've made the statement that to be in excess of 50% of shipments this year. And you can imagine with the 20% of the order book in the first half, that is going to flow through product revenue and product gross margin in the second half, and then have an incremental benefit as it reaches a higher level in 2022. Thanks for the call. Sure.

Thank you. Our next question comes from Rob Jost from Invesco. Please go ahead, Rob. Your line is now open.

Hi, thanks. I wanted to follow up on that last question. Have you quantified the margin uplift of the VN versus the legacy ATM?

For competitive reasons, we have not done so, Rob. Obviously, for internal modeling purposes, we have all that information. It's just not something we want to discuss. We don't want to discuss the unit costs of our ATMs. Sure. Okay.

I wanted to make sure I didn't miss it. When you talked about self-checkout, the comment on the slide was that this was regarding higher software and services. But in the follow-up, it sounded like services was fairly constant. I guess I just wanted to see if I could dig in a little bit here and understand. With the self-checkout, is there something unique about what you're selling now that is driving, I guess, higher software? It sounds like service levels are very constant.

Rob, you broke up there a little bit, so I'll take a crack at answering it. If you didn't answer it, just come back at it. So, you know, historically, if you go back a couple of years, self-checkout was a much smaller part of our retail portfolio. We've seen exceptionally strong tailwinds on that front. And also, historically, services and tax rates and point of sale were low in the 30% range. Self-checkout is a substantially more complex device, which is what's driving a much higher service and tax rate in our favor, the tax rate that's typically north of 95%. So every incremental self-checkout machine we sell increasingly drives up our recurring services revenues. So we fully expect to see ongoing strong growth in our self-checkout services revenue line. Software also gets dragged along. As our customers look to deploy both on-the-sale and self-checkout technologies, they rely on us for software to power those devices. So, again, this is a model where strong activity on the hardware front pulls through activity on services and software.

Okay. No, that helps answer that question. Okay. And then my last question was just around some of the pressures you're facing both on the logistics as well as just the cost materials. I heard you say that you expect this to last, to persist through the new year, Chinese New Year. I think it's around where you think it might mitigate a little bit. Which way are things trending at this point? Are they still going up? Are you in a stable environment? I'm just trying to get a feel for how to think about the next quarter.

Yeah, so let me break it into two different pieces. On the freight side, the inflationary pressures are high. We're modeling a modest uptick above what we're showing Q2 to the balance of the year on freight costs. which are quite high, and then are anticipating for them to abate hopefully around the Chinese New Year. But that's one factor. The other factor which I commented on in my prepared remarks is semiconductor demand is exceptionally high right now. I anticipate that that may tighten further through the year rather than abate. And that one may tighten somewhat further into 2022. It's a much smaller inflationary pressure on us. That's one of an availability question for us than an inflationary pressure question for us. So while a lot of this call has focused on the logistics side, I would just broadly say the overall supply chain environment is probably, not probably, definitively more complex than we've seen it in years.

Okay.

Thank you. Thank you. Our final question today comes from Barry Hames from Sage Asset Management. Please go ahead, Barry. Your line is now open.

Great. Thanks for taking my questions. So first one, just It's not clear to me on these additional freight and other costs as to whether and how aggressively you're trying to raise price or put in surcharges to offset. So could you comment on that? And to the extent you are trying to do that, is there a point in time where you think you'll catch up on a dollars basis on price-cost? That's the first question.

Yeah, Barry. Yeah, obviously, for competitive reasons, I'm going to be a little bit circumspect on that particular question, but I can tell you that across the board, across hardware services and software, we have implemented various measures to offset a bunch of this pressure that we're seeing. The flow-through effect of those measures starts to be felt more notably in 2022, just timing of orders, you know, when they were priced, when things were being built, and when revenue is being recognized. So, you know, I'd say more broadly, you know, we're bearing some of the inflationary brunt the second half of the year. We're continuing to take incremental cost measures to offset that. But on the pricing front, that tends to flow through into the following year.

Got it. Second question is, just getting to some of the free cash flow pieces for next year. And so without forecasting earnings and getting into any kind of an earnings forecast, but just in terms of other changes. So the $15 million on the restructuring costs, as I recall, doesn't repeat next year. So that would be a $50 benefit. And the $25 million reduction we've seen in EBITDA is Given that you think things might normalize earlier in the year, so, again, everything else equal, would that come back next year? And then are there any other free cash flow pieces that we should be thinking about?

Yeah. Yeah, and that's a good question. We are not only assuming that in 22 at some point in time that availability of cargo capacity will – improve but that the cost will adjust also so based on that yes it would come back right and then and then from a cash flow forecast perspective we we talked about will be a little heavy in inventory than we originally modeled uh that should come back right and also with with what Gerard said relative to the N-series final assembly capabilities closer in the U.S., that would help relieve some of the pressure on inventory. So we would assume that EBITDA would benefit, that we would see a reduction in the long position we're taking in certain inventory categories. We will get that back. You're right, the restructuring goes to zero. And then ultimately, and this is the question I received earlier, is we would anticipate if the debt markets hold that we'd be able to do something to reduce our interest payments going forward sometime in sometime in 22. But that's yet to be determined and is dependent upon market conditions and availability within the markets.

Got it. That's very helpful. Appreciate it. And last, sort of two questions. One is, you've alluded a couple times to the extra inventory this year that you had to put on. Could you quantify what that number is? And then lastly, if not for the supply chain issues, based on the strong order book, would your sales guide have actually gone up instead of staying flat on the reforecast? Or is a lot of the order strength more for delivery in 22, and it's really more of a 22 impact? Thanks very much.

Yeah. So the amount of inventory... And I can give it to you, that second quarter was in the $20 million range, right? $20 to $25 million of higher end. And we would anticipate that that level may continue through the end of the year. Yeah, the other question is a very interesting question. And I'm not going to answer it the way you asked. Here's the way I'm going to answer it. If we didn't have any supply chain issues, we would anticipate having a very good plunge above our own expectations.

Got it. Fair enough. Thanks very much. Appreciate all the insights. Okay. Thank you.

I just want to say thanks to everybody for joining today's call, and if you have follow-up questions, please reach out to our investor relations. Have a good day.

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