Diebold Nixdorf, Incorporated
Q3 2017 Earnings Call Transcript

Published: 31 Oct 2017

[Operator:]

Good day, everyone. Welcome to Diebold Nixdorf Q3 2017 Financial Results Conference Call. At this time, for opening remarks and introductions, I would like to turn the conference over to Mr. Steve Virostek. Please go ahead.

[Stephen A. Virostek:]

Thank you, and welcome to Diebold Nixdorf's third quarter earnings call for 2017. Joining me on the call today are Andy Mattes, President and Chief Executive Officer; Jürgen Wunram, Senior Vice President and Chief Operating Officer; and Chris Chapman, our Senior Vice President and Chief Financial Officer. Per our custom, we posted the presentation slides, which will accompany our discussion today and we posted them to the Investor Relations page of dieboldnixdorf.com. For your benefit, we'll post a replay of this webcast on the same website later today. Slide 2 contains a reminder that we'll be referring to both non-GAAP and pro forma financial information, which we believe are helpful indicators to the company's performance. We've reconciled these metrics to their respective and most directly comparable GAAP metrics in the supplemental schedules of both the earnings release and the slides. On slide 3, we remind everyone 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 factors in the company's SEC filings including our Form 10-Q filed this morning. As usual, this forward-looking information is current as of today and subsequent events may render this information out of date. Now, I will hand the call over to Andy.

[Andreas Walter Mattes:]

Thanks, Steve. Good morning, everyone, and thank you for joining our webcast today. There are many positive developments in our business, and we are encouraged to see our integration and transformation achievements begin to translate into meaningful cost synergies during the third quarter. The reductions to our operating expenses as well as in our cost of goods sold are noteworthy, especially in our Systems line of business. Profitability was also aided by assertive cost management and certain discrete benefits in the quarter, which Chris will discuss shortly. This progress enables us to tighten our full-year non-GAAP range to $1.05 to $1.15, which was the upper end of our prior range. At the same time, banking revenue and orders in the third quarter were below our expectations and we're lowering our revenue outlook to around $4.6 billion for 2017. It is clear that the ATM marketplace continues to be challenging just as we highlighted on our previous earnings call. First, regional and community bank spending on ATMs, especially in North America, has been lackluster ahead of the inevitable Windows 10 upgrade cycle, which we expect to materialize with increasing order activity in the late 2018. Second, the enhanced functionality of our Solutions and the increased complexity of bank IT environment adds to the sales cycles, prolongs implementation schedules and impacts the timing of revenue. Furthermore, ATM systems revenue from customers in the emerging markets, which has been an industry tailwind for several years, has waned due to lower volume growth and continued price competition. Retail Banking Research, an industry authority, has acknowledged the changing marketplace by reducing their global ATM shipment forecast by more than 60,000 units for 2017. The firm also cuts the annual growth rate of shipments through 2020 in half to about 2%. While we are well positioned to capture our fair share of these shipments, we will continue to lead the industry on price discipline and pursue margin-accretive deal. Going forward, we see significant opportunities in Services and Software, which accounted for more than 60% of our revenue in the quarter. To be sure, sluggish systems sales have influenced this ratio, but the important point is that about 45% of our total business is contractually committed and produces predictable recurring revenue. We're working hard to increase this ratio by upgrading our managed services, ATM-as-a-service and Software-as-a-Service offering. As previously discussed on the prior earnings call, we're making incremental investments in the Services organization in the form of additional technicians, training, our global delivery centers and IT tools. These investments extend our competitive advantage benefiting current customers and better positioning us to capture new opportunity. I am pleased to report that on a year-to-date basis, we have renewed large multi-year service contracts valued at approximately $900 million and our renewal rate is close to 100%. During the third quarter alone, we signed multi-year contracts valued at more than $300 million with about 25% representing incremental revenue for the company. New contract wins in the quarter included a seven-year $40 million contract in the U.S. with a leading independent ATM deployer to maintain about 4,000 terminals while enabling cardless transactions; a three-year $12 million services contract with Bank Mandiri, a top three bank in Indonesia; and a three-year store lifecycle management worth nearly $10 million with a multinational clothing retailer which is expanding its presence in Russia. Contract renewals with an increased value and scope of work included a four-year $54 million maintenance service contract with Banco do Brasil, a five-year managed services contract with a multinational bank to provide remote management and monitoring for more than 5,000 ATMs in the UK and the U.S., and a five-year installation and maintenance services contract with a large logistics company in Germany for 12,000 payment terminals. Other contract renewals during the quarter included a three-year $36 million IT outsourcing contract in Germany with HSH Nordbank and a one-year $30 million managed services ATM contract with Geldservices (sic) [Geldservice] (00

[Jürgen Wunram:]

Thanks, Andy, and hello, everyone. As Andy mentioned, you can clearly see the benefits of our holistic DN2020 program, which includes our integration and operational excellence initiatives. We set up a very structured framework for this program, which includes cost reduction initiatives across the company together with strategic improvement initiatives, while keeping our focus on the customer. Through our set-up and execution of the program, we have managed to accelerate our cost savings. We have increased our 2017 cost synergy target from $50 million to $75 million. The incremental $25 million of cost savings were the result of the accelerated reduction of our OpEx spend, indirect and direct procurement, global field service integration as well as fast track progress with our supply chain and manufacturing measures. As a result of our integration activities, we will have reduced nearly 1,000 redundant head count positions by the end of 2017, the majority of which has already occurred. We have consolidated our supplier base and renegotiated greater than 90% of our direct material spend. We have integrated more than one-third of our redundant country legal entities. We have reduced the number of self-service terminals by more than 50% and consolidated 240 out of approximately 1,000 of our service parts depots around the globe. The Hungary manufacturing plant and the Netherlands logistics center have also been closed. Next, I will go into a deeper dive into a view of our integration project that's also showing real progress and benefiting our bottom line. Let me first start with the progress we have made on reducing our operating expense, which is an important component of our DN2020 program and which is imperative in optimizing our cost structure and accelerating savings. We have taken a structured approach in reducing our G&A at a total company, regional, and functional level with detailed targets for each of these areas. By focusing on back office support functions and redundant corporate and regional management, we have reduced G&A through process improvements, enhanced use of shared services, and enabling of efficiency resulting in head count reduction and reduced external spend. We have also reduced the R&D spend through the elimination of redundant products, streamlining and reducing the complexity of the portfolio, and refocusing of our R&D spend in line with our connected commerce strategy. Our legal entity consolidation project is a conduit for simplifying employee and customer interactions across the countries in which we operate. Our objective is to simplify sales (00

[Christopher A. Chapman:]

Thanks, Jürgen, and good morning, everyone. My comments today will focus on our non-GAAP results from continuing operations unless otherwise noted. In order to help facilitate more meaningful comparisons, we are also providing select pro forma information for the year-ago period. Starting on slide 7, we compared total revenue for the third quarter 2017 with pro forma revenue from the year-ago period. On a constant currency basis, revenue decreased 14% primarily in the Systems line of business due to weaker banking sales and a non-repeating voting terminal contract in Brazil, which is now part of our retail business. Looking at the mix of revenue on a GAAP basis, Services and Software accounted for 65% of the business, while Systems accounted for 35%. The geographic mix of revenue was 52% in EMEA, 35% in the Americas and 13% from Asia Pacific. Looking at our solutions, banking accounted for 75%, and retail was 25% of total revenue. Moving to slide 8, we've provided a comparison of key non-GAAP profit metrics for the quarter with pro forma results from the prior year. The $23 million change in gross profit was primarily due to lower volume in our Systems line of business and a corresponding reduction in the installation revenue, which is part of our Services line of business. Operating profit increased approximately $29 million, and operating margin improved to 7.3%, as lower operating expense more than offset the change in gross profit. Operating expense in the quarter improved $52 million compared to the pro forma 2016 results due to the cost synergy benefits and assertive cost management. It also includes lower incentive compensation of expense of around $13 million in the quarter including an approximate $7 million adjustment related to a mark-to-market compensation program. Our adjusted EBITDA of $124 million improved by approximately $32 million from the prior year pro forma results reflecting the increase in operating profit. Turning to slide 9, non-GAAP Services revenue decreased 4% in constant currency when compared to pro forma results in the year-ago period. This was due primarily to lower product-related installation activity for banking customers as well as lower contract service volume both in the Americas and EMEA tied to multi-vendor and IT contracts that were not renewed. Service gross margin of 25.4% declined approximately 160 basis points versus pro forma financials in the year-ago period due to lower contract and installation volume, coupled with continued investments in our service technicians and training. On a sequential basis, Service gross margin increased 70 basis points on improved volume. Looking at slide 10, Systems revenue decreased 28% in constant currency compared to the prior year pro forma period. The primary driver was lower banking activity in the Americas and EMEA. Retail systems revenue was down slightly excluding the previously-mentioned non-repeating Brazil voting contract on a difficult compare. Systems gross margin increased 360 basis points to 20.7% compared to pro forma results from the previous year despite a decline in revenue. Our gross margin improvement is a combination of continued price discipline as well as the synergy benefits from renegotiating our direct spend, trimming manufacturing capacity and streamlining our portfolio. Turning to slide 11, Software revenue of $117 million decreased 6% in constant currency compared to prior year pro forma, mainly driven by the timing of projects in EMEA. The Software gross margin decreased slightly year-over-year. Moving to slide 12, non-GAAP EPS was $0.58 for the quarter, which is a $0.24 improvement compared to the previous year reflecting the higher operating profit and a slightly lower tax rate. Non-GAAP EPS for the current period excludes restructuring expense of $0.23 and non-routine expense of $0.96. The non-routine expense consists of $0.26 of acquisition integration expense, Nixdorf purchase price accounting adjustments of $0.61 and other net non-routine expense of $0.09 mainly related to a divestiture in Latin America. The tax impact for restructuring and non-routine items inclusive of allocation of discrete tax impacts was $0.14. During the quarter and on a year-to-date basis, the non-GAAP effective tax rate was 18.3% contributing around $0.08 to the quarter versus our previous estimate. In the third quarter, our non-GAAP effective tax rate reflects a benefit from the recognition of foreign tax credit associated with repatriation of funds to the U.S. As a result of this benefit, we are adjusting our full-year non-GAAP tax rate to be around 20%. On slide 13, free cash used was approximately $65 million in the third quarter, which compares with breakeven in the prior year. Improved operating profit and lowered deal-related expenses were offset by higher severance and integration payments as well as higher inventory levels. The increase in inventory is in support of customer projects and a temporary increase in levels while we rationalize our manufacturing footprint. On a year-to-date basis, free cash use of $277 million is $67 million more than the year-ago result. On the right side of the slide, we provide highlights of our liquidity and net debt position. As of September 30, we reported cash on hand of $445 million and gross debt of $1.9 billion, resulting in net debt of approximately $1.5 billion. To provide a perspective on our net leverage ratio, if you look at the trailing 12 months adjusted EBITDA, the net debt to adjusted EBITDA is 3.8 times. Moving to our outlook on slide 14, as Andy indicated, our revised revenue outlook is for approximately $4.6 billion with the anticipated currency impact of around 1% on a full-year basis. The company expects a net loss of $130 million to $140 million on a GAAP basis for the year. Adjusted EBITDA is projected to be between $370 million to $380 million, which is at the upper end of our prior range. This now assumes the realization of around $75 million of cost synergies, includes depreciation and amortization of expense of approximately $115 million, and share-based compensation of approximately $13 million. On a non-GAAP basis, we expect EPS of $1.05 to $1.15 for the year, which is also at the upper end of our prior range inclusive of a non-GAAP effective tax rate of around 20%. Looking to the fourth quarter, we expect an increase in revenue over the third quarter levels, primarily from our Systems line of business. Our anticipated mix of revenue will likely result in a modest sequential decline in gross margin. Operating expense is expected to be sequentially higher in the fourth quarter as a result of an increased selling due to higher activity – selling expense due to higher activity, increased investments in R&D and the absence of the non-repeating benefit of lower incentive compensation expense, which I highlighted earlier. Our free cash flow outlook for the year remains at breakeven with capital spending now expected to be around $75 million. As a reminder, free cash flow for the year could be influenced by the timing of certain integration and restructuring costs, which increased approximately $15 million to $135 million. With that, I will open up the call for questions.

[Operator:]

We'll have our first question from Paul Coster with JPMorgan.

[Paul Coster:]

Yes. Thanks very much. A quick question on cash flow. I mean the debt has increased for the last couple of quarters and so debt to EBITDA ratio is at 3.8 times. Are there any covenants that we should be aware of that – from an equity perspective that might get triggered if it deteriorates any further? And what do you expect sort of the cash flow and sort of receivables inventory balances in this fourth quarter? Thank you.

[Christopher A. Chapman:]

From a covenants standpoint, Paul, we're in good shape there. We've got all of the covenants obviously are out public. We've got 4.5 times on the net debt to adjusted EBITDA. And so with the seasonal increase from a Q4 standpoint, we're going to end the year with a lower net debt position, and so we'll have plenty of capacity on that as well. If you look at the working capital items that you've highlighted, typical year-end based on pro forma company results, we should be somewhere in that net working capital as a trailing – as a percent of trailing 12-month revenue somewhere in that 20%, 21% range is what we'd estimate based on our current forecast right now, understanding we're a little bit higher right now in seasonal inventories, and we expect to drive that down as we go into the quarter.

[Paul Coster:]

Yeah. Very good. Thank you. And then, Andy, the bank transformation doesn't seem to get much airtime all of a sudden, and we're seeing these strange delays that don't make much sense to many of us on the outside. Eventually, presumably (00

[Andreas Walter Mattes:]

Paul, a good question indeed. I'd say people start to bundle those two activities into one stream, and Windows 10 is – I mean as you know Microsoft that they're going to sunset Windows 7 by the end of 2019. So our expectation and the feedback that I'm getting from the market is that customers are now starting to do the CapEx planning, they're putting it into their budget cycles. We expect orders around Win 10 upgrades to come in towards the end of 2018, revenue is probably going to be predominantly in 2019, and people are bundling activities from who is investing. It's still a large multinational bank play and you can see that with all the wins that's happening here in the Americas, it's happening in Europe. The larger the bank, the more ahead of the curve they are. The smaller the bank, the more they're waiting on the Win 10 upgrade until they get closer to the deadline.

[Paul Coster:]

And one of these big deals so complex. What's changed?

[Andreas Walter Mattes:]

We've been talking about omni-channel to the point that nobody can hear the word anymore, but you have to – what it really means for all of us in the industry is that these solutions have to get integrated into a multitude of software channels and towers. And that's just a level of complexity, not just for us, it's also a level of complexity for the bank. And if they're doing some major upgrade, we might be delayed because the bank is upgrading their CRM systems. It's also on the branch transformation side, it's very closely linked to whenever banks are redesigning their branches. And those projects too have a tendency to move and aren't quite as fixed from a scheduling point of view. So, rule of thumb, it's a big deal market. And the bigger the deals, the longer it takes from orders to revenue.

[Paul Coster:]

Okay. Thank you.

[Operator:]

We'll go next to Matt Summerville, Alembic Global Advisors.

[Matt J. Summerville:]

Thanks. Good morning. Chris, in the past, you've sort of walked through kind of the cadence you anticipated as far as realizing the $240 million and if you just do the math, $75 million on $240 million is 31%. So maybe a little color on how much we should expect to be realized in 2018 and 2019? What's the updated roll forward if you will of that realization?

[Christopher A. Chapman:]

Yeah. The update, and obviously we're not going to go through full detailed 2018 outlook today, but if you think about 2018 based on the trajectory that we have with our cost out, I'd say we're going to be somewhere around the 50% mark of the full realization in 2018, and then obviously we'll update on 2019 and 2020 at a later date.

[Matt J. Summerville:]

And then, similarly if you think about again more at a high level given what you basically were at $4.7 billion to $4.8 billion in revenue, now you are at $4.6 billion, so you took another $150 million out, what's the right way to think about the revenue cadence based on some of Andy's comments, as we think about 2018, the right way to start to build up an 2018 model, so as expectations if you will early on in the year don't get out in front of reality for you guys? Thank you.

[Andreas Walter Mattes:]

Matt, this is Andy. I don't see a fundamental change in the behavioral patterns of the large banks from end of 2017 going into the first half of 2018, so I would expect revenue picture in the first half of 2018 to be basically mirroring the activities that we see in the markets in the second half of 2017, do believe that the Win 10 upgrade will change the order picture especially in the Americas because, especially in North America, all the banks are very concerned about PCI compliance, so they usually want to get their orders in ahead of the curve, but that's more an order play than a revenue play. So, modest start into the year with a opportunity to be better towards the back end.

[Christopher A. Chapman:]

Yeah. And I would just add a couple of quick points on that. I would say on the Windows 10 upgrade activity, from an order perspective, I would expect that to be more of the second half of 2018 where you'd see that trajectory start to push up. And so, obviously, we have to see how the timing of everything works and how the backlog looks where we anticipate entering 2018 with a slight increase in backlog from where we were last year, but obviously the timing and the pace of those orders will determine that. And so I think, as Andy said, 2018 is going to be in the first half stubbornly similar to what we've seen in 2017.

[Matt J. Summerville:]

And just one quick follow-up to that, Chris. What was your backlog at the end of the third quarter? And then I'll get back in queue. Thanks.

[Christopher A. Chapman:]

Our backlog at the third quarter was roughly flat with where we were at the end of the second quarter, so around the $1.2 billion level.

[Matt J. Summerville:]

Thank you.

[Operator:]

We'll go next to Paul Condra, Credit Suisse. Paul Condra - Credit Suisse Securities (USA) LLC Hey. Good morning, everybody. Thanks. Just can you – with the tax rate, should we – I don't know if you said, should we expect that to be 2018 tax rate also?

[Christopher A. Chapman:]

Right now, I would say the tax rate for 2018, and obviously we've got to see some of the final work that we do around our legal entity consolidation and additional planning work, and it's very difficult to predict what's going to go on with U.S. tax rate. Won't comment any further on that one. But right now, I would just say planning to that mid- to upper-20s for 2018 would be the appropriate view, and we'll update that in the future. We do have a discrete benefit coming through that's given us a little bit of a lower rate here, and we'll continue to work and do our best to continue to drive those benefits through the overall tax rate as well. Paul Condra - Credit Suisse Securities (USA) LLC Okay. Great. And then you mentioned the unattached software sales, some progress there. Just can you kind of give us the mix of how much of the software business is unattached and how that's sort of trending?

[Andreas Walter Mattes:]

I'd say it's about half and half, Paul. And it's trending north and the good news is in both segments, in banking as well as in retail. Paul Condra - Credit Suisse Securities (USA) LLC Okay. And then, I also just wanted to ask on the reduced industry shipment data to 2% from – you said it was by half. So I guess it was about 4% prior. What regions or where are the biggest reductions in the outlook and how are you thinking about that in relation to your exposure?

[Andreas Walter Mattes:]

I'll summarize it in a crude manner. Americas and Europe basically flat. In some cases, if you click into the subcategories and you might even have a slight negative growth rate, AT (00

[Andreas Walter Mattes:]

Basically the 60,000 units, they took out from all over the world, but also of course in the Americas and Europe. But as I've said, simple rule of thumb, flat Americas, Europe, little bit of growth in Asia, but substantially less due to the fact that China is not the growth engine that it used to be. Now keep in mind, those are unit shipments. So if you then apply an average pricing headwind that this industry has like any mature industry of, let's say, 2% to 3% on the hardware side, you know what that means for us. We got to actually sell more units to stay flat and/or to start to increase our revenues. Paul Condra - Credit Suisse Securities (USA) LLC Okay. Great. Thank you.

[Operator:]

And we'll go next to Kartik Mehta with Northcoast Research.

[Kartik Mehta:]

Hey, good morning, Andy and Chris. Andy, we know we've talked about the ATM industry and what's happened this year, but it seems as though if I looked at those industry shipments you quoted, maybe the price declines that you're going to face, it seems as though – is it any more than that? It seems as the industry is down a lot more than maybe some of the industry numbers would suggest at least for you and your largest competitors, so the biggest part of the market.

[Andreas Walter Mattes:]

Kartik, the biggest thing, if you look at what has changed over the last four, five years is the developed markets have never been super-fast growing, but we were always as an industry able to compensate, in many cases overcompensate in the emerging markets, and the emerging markets basically are vanishing and/or are moving into crazy price territories where we don't want to go, given that we said we will remain prudent on price levels. So, China is basically – is a non-issue especially because we've moved it out into joint ventures. India, super-complicated market, horrific price configurations. Brazil has gone from being confident about its future back into having many question marks about where the economy is going. So, that's no big engine. South Africa, commodity-based, also more on the underwhelming side of the growth ratio. So it's – no help from the emerging markets, and the other thing is those countries were also the ones where we could turn orders to revenue in shorter time intervals, and you see both of it. So as we said, when we did the deal, our prediction for the industry all along was for the next three to four years, it's a developed market play, it's a Services play, it's a Software play, it's a Software-as-a-Services play, but the more you go down that route, you're looking at different type of growth rates. So the growth rates will be smaller but the recurring monthly revenue will go up, and the perpetuity of the revenue will get bigger as you go into the out years.

[Kartik Mehta:]

Thanks, Andy. What about – you've talked about now wanting to be the price leader in a lot of these markets. Are you giving up share in any of those markets because you don't want to forsake margin or go with almost zero margin hardware sales?

[Andreas Walter Mattes:]

Absolutely. Kartik, there's – I can give you quite a few countries in Asia where we will – we're not willing to go. We won't do negative hardware margin deals as a company. It's not worth the effort.

[Kartik Mehta:]

And then, just last question, Andy. Obviously I believe you announced the resignation of the chairman. I'm wondering if you could just comment on that, the reasoning behind that and if that was something that was already being planned by the board?

[Andreas Walter Mattes:]

Look, we – Kartik, this is just a normal succession process within the board. Henry has been the chair for five years by the time he will step down from the chairmanship. He has done a terrific job for the company all across those five years. He's been a great supporter and a big supporter of our strategy. He helped us see through the deal and do the integration work and get all of that teed up properly. And now the board is just changing their workload and their assignments. Henry will remain on the board. So you have consistency while at the same time we have a new chairman starting January 1, and Gary is very active. He's extremely well networked in the industry and is going to help us through the next years going forward. And I am super-excited to work with him. Gary joined the company, I want to say, some three years ago, and he's been a great add to the board and is a great partner and a great coach.

[Kartik Mehta:]

Thanks, Andy. Appreciate it.

[Operator:]

We'll go next to Justin Bergner with Gabelli & Company.

[Justin Laurence Bergner:]

Good morning, Andy.

[Andreas Walter Mattes:]

Good morning, Justin.

[Justin Laurence Bergner:]

Good morning, Chris. I guess to start, it'd be good to understand the cash flow bridge that allows you to preserve the breakeven free cash flow guide for the year, just the different puts and takes versus prior.

[Christopher A. Chapman:]

Yeah. I mean the biggest driver, and again you can go back and you can look at the seasonal history of the company, the fourth quarter is typically the biggest cash quarter of the year. And so you're going to see a couple of things, and it's really going to be around three main areas. Number one, the inventory drives down with the final activity and final installations for the year, and typically the plants are a little more idled towards the end of the year, so you see that run down as well. Number two, you typically see the big drop in the receivables as a lot of customers will pay ahead of terms and drive those payments as we go throughout the fourth quarter. And then the last big piece as well which is this part of the legacy of Diebold is that we have our annual service contract renewals that go out, and there's a lot of pay ahead for those annual contracts or paying on those annual contracts. And so you typically see that big push into the overall deferred revenue. And so it's following the seasonal pattern. So, that's going to be the big driver of activity from where you were at in Q3 levels from a balance sheet standpoint to how we finish the full year. Now as I've noted several times though and you can see it here in the third quarter, we have paid out a little bit higher on the restructuring. I noted that back in the second quarter that if we have the opportunity to get some of those severance payments and things of that nature behind us and expedite the exits, we would do so. We were successful on that in Q3. And so to the extent that we can still accelerate certain restructuring integration activity and get that behind us, obviously that's in our best long-term interest, and we'll continue to do that and that could weigh against some of the cash flow performance.

[Justin Laurence Bergner:]

Okay. I think that's helpful. I was wondering a little bit more in terms of the bridge from the prior guidance. Is the CapEx changed or tweaked, is the working capital changed or tweaked versus 2Q (00

[Christopher A. Chapman:]

No. The CapEx came down a little bit. My integration, restructuring payments went up a little bit. The rest has more or less stayed very similar to what we had previously talked about on the Q2 call.

[Justin Laurence Bergner:]

Okay. Great. And then at the start of the call, I think you guys mentioned some one-time factors that helped results, and I know you called out some things in regards to tax rate, but I was just wanting to make sure that I captured the essence of what you were referring to at the start of the call?

[Christopher A. Chapman:]

Yeah. If you go through – and let me just work my way down the P&L first, and so if you look at it in terms of a plus, the incentive comp is giving us a benefit to the Q3 results. We have a mark-to-market compensation program that gave us roughly $7 million benefit. The overall performance for the year means there's going to be less incentive comp paid out to certain individuals in certain parts of the business, and so that is driving an additional benefit as well in that form of a reduction there. And so we quantified that the compare we gave was versus prior year, but you can use it as roughly the same amount in the quarter on a sequential basis of around $13 million, that's given us a benefit in op expense. And so if you then walk down to the tax rate as well, the lower tax rate's given us roughly $0.10, $0.11 on the full-year basis as well when you look at those items. And so if you look at that in terms of one-time, those are benefiting us versus where we were at in the previous guidance.

[Justin Laurence Bergner:]

Okay. And then of that incentive comp, I guess the $13 million benefit will be essentially one-time?

[Christopher A. Chapman:]

Correct. We're not looking at it to repeat at the same level or at any substantial level in the fourth quarter.

[Justin Laurence Bergner:]

Okay. And then just one more question. I guess when you talked about renewal rates of 100% on service contracts, is that excluding the multi-vendor service, is that simply for Diebold equipment service contracts?

[Andreas Walter Mattes:]

That excludes the run-off that we've talked about in the previous earnings call. But with the exception of that phenomena, we were able to contractually reengage with every one of our large service customers during the year.

[Justin Laurence Bergner:]

Okay. And what's the historical renewal rate? I mean if it's close to 100%, just to understand how much better it is then maybe two years ago, for example?

[Andreas Walter Mattes:]

For legacy Diebold, it has always been north of 90%. But the fact that we're now able to get into similar, if not even better, territory as a combined company especially as legacy Nixdorf had a different service profile around the world, in my view is very encouraging.

[Justin Laurence Bergner:]

Okay. Thank you.

[Operator:]

We'll go next to Joan Tong with Sidoti & Company.

[Joan K. Tong:]

Good morning. Andy, you talk about like the projected growth rate for ATM shipment has come down by half, and there are some pricing issues as well. It seems like the growth rate for the next couple of years going to be lower organically. So I'm just wondering I know that you have used to digesting and integrating Wincor, but just wondering [Technical Difficulty] (00

[Andreas Walter Mattes:]

Joan, you did drop your headset. The second – can you hear. Joan? Hello? Hello?

[Joan K. Tong:]

Hello. Yes.

[Andreas Walter Mattes:]

Joan, you dropped your mic. We got the first part of the question, when you talked about the out year, and then you started to become company specific with your question, and unfortunately your headset was playing tricks on you, so I couldn't hear the question.

[Operator:]

And when she returns to the queue, we'll re-prompt for her question. We'll go next to Jeff Kessler, Imperial Capital.

[Jeffrey Ted Kessler:]

Thank you. Could you talk a little bit about both R&D and CapEx, and where obviously diversifying the revenue stream is what you're doing. I'd like to find out into – you just mentioned – you've just mentioned something like getting your first cash recycling contract, an area that is not exactly new, but an area that is relatively new for the whole industry in a large revenue sense. I'm wondering what other areas present areas of growth for you, what types of investments do you have to make to get to those growth areas?

[Andreas Walter Mattes:]

Jeff, this is Andy. So, first of all, the recycling contract, that was the first for that specific customer which is Banco Santander, we have been in the recycling business for quite a while. For the acquisition of Nixdorf, we now have our own recycling IT, which is a great asset from an IT point of view. And if you take a look as recycling is pretty much a wave that started in Asia, has already manifested itself in Eastern Europe, so in Russia, Turkey, and is now coming to Western Europe and to the Americas. So we're extremely excited that, in Spain, this technology is now starting to resonate and some very large banks are starting to experiment with that. And of course that's one area where we include our R&D. From an R&D point of view, and I think I said that at the last earnings call, we're now at a point where more than half of our R&D spend is actually targeted towards new innovation versus keeping the existing machines up and running. And as we streamline the hardware portfolio, this mix is going to shift even more towards innovation, and within the innovations, it's – the lion share is going to Software going forward because that's the key differentiating asset. And we've always said from the very beginning that we will not drive huge cost savings in R&D and take them to the bottom line, but that the cost savings on the R&D front will basically self-fund the innovation engine of our company because I truly believe that without the necessary IT, we won't be able to sustain a healthy growth rate for the company in the long run. And software and all the assets around it will be the key differentiating factors.

[Christopher A. Chapman:]

Yeah. And just a quick comment around the CapEx side of that. I mean this year, we're looking at $75 million, and I would say majority of that CapEx is really more specific to our internal investments. But as we go forward, I would expect to see more, will say, customer-facing CapEx type of spending where we have some of the managed service and outsourced opportunities where we have some investments to make there. And so obviously, as we talk more about those opportunities and those revenue streams in the future, we'll update on the CapEx, but I would see a shift over the coming years to more of that customer-facing CapEx.

[Jeffrey Ted Kessler:]

Thank you. Could you just briefly, from an overarching point of view, describe some of the applications that the Software area is going to drive?

[Andreas Walter Mattes:]

This is where you get into our whole vision of connected commerce. So let me just try to do this very high level here. But the opportunity to look at all channels within a bank and outside of a bank including connecting bank apps into retail online apps is a very important element here. It goes into the area of data analytics, it goes into the whole area of branch and store lifecycle management, into tools, into predictive analytics and predictive maintenance, so quite a few revenue-generating initiatives and other huge push on the – starting on the retail side, but also getting more prominent on the banking side is our whole investment into customer engagement and loyalty. So these are pretty much high-level areas where the R&D spend is going, going forward.

[Jeffrey Ted Kessler:]

Okay. Great. Thank you very much.

[Operator:]

We'll go next to Matt Summerville, Alembic Global Advisors.

[Matt J. Summerville:]

Thanks. I have a couple of follow-ups. First, can you talk about what drove the sequential improvement you saw in both Services revenue and gross margin? And on the latter, I'm really trying to get a feel for whether or not you're seeing actual abatement in some of the headwinds you faced in the first half of the year around attrition, inflationary pressures, training, retraining, all that stuff?

[Christopher A. Chapman:]

Yeah, Matt, if you look at the sequential improvement, Q2, Q3 from a service standpoint, as Andy talked about, first of all, we didn't experience, we'll say, any meaningful run-off, but start there. So the foundation of the service stream was in pretty good shape, and we also then on top of that brought in some new contract base, call that roughly one-third of the sequential increase and then we always have various projects and there was pretty heavy time and material activity that we had. Some of that centered around the Americas. And so, but on a global basis, we've seen higher time and material and then the improvement in the overall contract base and obviously with the cost foundation that we have in place (01

[Matt J. Summerville:]

And then just a couple other things. First, to one of my earlier questions, Chris, could you just clarify the cost savings of $75 million in 2018, is that an actual realized number or is that an exit run rate? I guess at the end of the day, I'm trying to get a feel for if we should be factoring in $45 million of incremental realized savings in 2018 based on your comments or whether or not that number is actually bigger on a realized basis because the $75 million is an exit rate?

[Christopher A. Chapman:]

Yeah, the $75 million would be the realized amount in the current year. Obviously, we will get some of the benefits as we go into next year on some of the people aspect of that and so it's not the full – we're not reflecting the full run rate benefit as of yet and so we get some of that benefit as we start to overlap quarters than into 2018. So by taking the early actions, we help to solidify the additional cost program benefits that we get into 2018.

[Matt J. Summerville:]

And then just two more quick ones. Maybe Andy, can you talk about – just give an update on some of the big outsourcing deals you had been talking about earlier in the year? Where are you in that process? Things seemed to have gone at least radio silent, no commentary in your prepared remarks here. So an update on the big outsourcing deals? And then, Chris, if you can clarify on slide 14, why the purchase price accounting went from $1.90 to $2.10? Thank you.

[Andreas Walter Mattes:]

Well, look, Matt, if you take a look is the – in the – one of the wins we talked about, that actually includes the outsourcing deal for about 5,000 ATMs across the U.S. and the UK. So one of them materialized in the year. We have a few very big opportunities in the funnel, but those are extremely binary, zero or hero, and we will not talk about projects of such an order of magnitude unless we have full agreement with the customer to do so. Having said that, what you can see, I mean $300 million in TCV in service renewals for a quarter, and those are just deals that we called out that did not include a lot of the smaller bank stuff that we do, in my mind, is a very solid number, and it should give you a sense that this movement towards a managed services, ATM-as-a-service, that's a progress that we will see continue to go forward, and that's also an area where we're extremely uniquely positioned in the market, and that's where we compete with the large outsourcers of the world more so than with our traditional competitors, and we are extremely excited about that opportunity.

[Christopher A. Chapman:]

And your question, Matt, if you look at the overall purchase price accounting adjustments, we were at the end of the 12-month period finalized all previous estimates and all work around the overall valuation and there were various areas where there was adjustments to the original estimates, and we pushed all of that through then from an expense standpoint for majority of those adjustments in the third quarter, basically doing a life to-date true-up from that beginning period from Q3 2016. So, that's why you're going to see it heavier in Q3 and then that Q3 heavier amount versus where we were at in previous periods and runs through on the full-year basis, and then it's going to normalize roughly around probably $30 million from a dollar standpoint around $0.40 in a quarter each quarter after that, it'll stay fairly stable at that rate then into 2018, but maybe some small adjustments.

[Matt J. Summerville:]

Got it. Thanks again.

[Operator:]

We'll go next to Rob Wildhack with Autonomous Research.

[Robert Wildhack:]

Hi, guys. Question on the expenses and margins. You mentioned about some higher OpEx in the fourth quarter, and given that it sounds like slightly lower margins in the fourth quarter, how should we think about the run rate margin profile of the business in terms of baseline moving forward?

[Christopher A. Chapman:]

No, I would say that if you look at the external targets we've been talking about and where the current trajectory is at, just breaking it down by a line of business, I'd expect the Services business to continue to work its way up as we've gotten some of the benefits from our integration activities and as we start to grow the overall service line, and so moving that up from that mid-25% level and continuing to walk it up. We've talked about our longer-term view of getting that up towards – towards the 30% level. Obviously, that's going to take some volume and some additional activity to help drive and support that, but I would say the baseline in that mid-25% level, I'm starting to work up from there on the systems side. Obviously mix and price are going to play a big factor here. We've done a nice job of stabilizing in that high 19%, low 20% level. And we're obviously not satisfied on the cost side, but we're going to be continuing to fight the price pressure. So I would say 19% to 20% level there is going to be – on the gross margin side is going to be an appropriate view there more of a longer term. And then Software is also going to be mix dependent with regards to some of the professional service and the additional ability to drive higher license and maintenance revenue through there, so right now in that mid-35% level. And I would say that's going to be a little bit longer tail to improve just in terms of driving the higher mix of the license Software-as-a-Service revenue and the maintenance service through there to offset the lower margin professional service.

[Robert Wildhack:]

Got it. And then maybe more broadly on the retail business, what's the demand like from retailers right now? Are there any verticals or specific merchant types where you're having more success than others?

[Jürgen Wunram:]

Yeah. Maybe I take that question. Jürgen speaking. So, on the retail side, actually if we exclude the specific comp that Chris has talked about, I think we are quite happy with our retail performance so far. And it is also after being last year a very, very strong this year again, so we are quite satisfied with that. We are building on our strengths of course in EMEA and here everything what we do in store management plays a very good play. That means of course persons go on in-depth, and they go together with associated store management software. On the other hand, we have our value proposition and store lifecycle management, which has been in the past and we continue to be a very good and positive growth engine. So also there we are pretty, pretty happy about that. Looking for the Americas, I think this is more like a greenfield growth area for us. Definitely, we can bring to the party, so to say, our global customers and we do business with them in the Americas and also some – as you might know some grocery retailers of Germany are entering the U.S. market that could also be of the benefit. But at the end, I think the Americas will be – for local customers will be in 2018, I would say, more like of the order play. And then in 2019, we expect more like a revenue play on that part. So, that should give you kind of a picture on where we stand in terms of retail.

[Robert Wildhack:]

Got it. Thank you.

[Operator:]

And we'll go next to Saliq Khan, Imperial Capital.

[Saliq Jamil Khan:]

Hi, guys. My questions were already answered. Thank you.

[Andreas Walter Mattes:]

Thank you, Saliq.

[Christopher A. Chapman:]

Thank you, Saliq.

[Operator:]

And we'll go next to Joan Tong, Sidoti & Company.

[Joan K. Tong:]

Good morning. I'm sorry, I was disconnected. So my question was related to your appetite for M&A going forward. Understanding you are integrating the business, integrating Wincor, but with the growth rate through 2020 projected to cut by half, just wanted to see if you can make up for some of those top line slowdown with acquisition in terms of perhaps acquisition or even partnership.

[Christopher A. Chapman:]

No, Joan, what I would say is, just look at the last several quarters, we continue to look at some small tuck-in acquisitions to round out areas of the portfolio specifically in the Software or Services area, and we'll continue to look at those selectively. We've also talked about various partnerships, Kony being the most recent, and we'll continue to look at those opportunities as well, as we move forward. And I think that's where continuing to focus on those areas will be key. We're not looking at anything, we'll say, of size or substance at this time and probably wouldn't be here in the near future either.

[Joan K. Tong:]

Okay. And then my next question, it's related to the regional banks. I mean it has been – like over the past two years, we have been waiting for that pickup in demand. So Andy, in your opinion, what has to happen to – for the demand to pick up?

[Andreas Walter Mattes:]

Look, I think that's predominantly a North American phenomena. I think three things will play for the regional banks to get moving; (a) Windows 10 will definitely get them to the table to have the conversations; (b) The technology advancements of the large banks versus the regional banks. Think about contactless cash just as one example, so you can withdraw money from your ATM through your mobile phone. The user experience at some of the regional machines would just feel outdated. So there's a market push to innovate. And then of course you have the third leg of the stool is when and if interest rates keep on moving north, deposits in a bank will become more relevant again, and there is no better channel to address deposits than the ATM channel. So you tie all three things together, and that should give you a pretty good reason why the regional banks have started. If you want to do it from a math, math point of view, the last big upgrade cycle in the Americas was in 2012. Most financial institutions depreciate the assets over seven years. So the end of the book life of the technology pairs up pretty nicely with the technology trends that I just gave you, which is why we believe that the regional banks should come back to the table towards the end of the decade, and you can see that, you can also see that in our orders now with the U.S. Bank example. So we're going from the top three, top four banks. We're now seeing more activity on the super-regionals, and then it's going to flow down to the non-regional banks in the timeframes I just gave you.

[Joan K. Tong:]

Got it. That's very helpful. And then finally on the retail side, Andy, have you touched on any – the progress on retail vertical market, and you mentioned in the past one of the key strategy is to go after businesses in the U.S. So just wanted to see what the progress there? Thank you.

[Andreas Walter Mattes:]

Let me just repeat what Jürgen was saying earlier. The Americas on retail is all greenfield for us. And the good news is, we've got a lot of interest. The good news is, we have quite a few exciting proof of concepts out there with retailers, but by the same token, it takes a while until people change their behavioral pattern, it takes a while until you integrate with respective software stacks that they have. So we expect this to be an 2018 orders opportunity and a 2019 revenue impact for retail in the Americas for Diebold Nixdorf.

[Joan K. Tong:]

And with what's going on with the brick-and-mortar in the U.S. like, have you seen some sort of like maybe pushback in terms of just clients or potential clients just don't have the appetite right now?

[Andreas Walter Mattes:]

Au contraire, I think with the acquisition of Whole Foods by Amazon, the whole revitalization of online plus physical presence is very topical. So if you talk to any retailers, they're not talking about brick-and-mortar is going out of style, they're talking about integrating brick-and-mortar into their overall value proposition. And it's a new way to approach the customers, but it's very much a connected commerce type of environment, and you'll see us play on multiple fronts in that as we go forward.

[Joan K. Tong:]

All right. Great. Thank you so much.

[Andreas Walter Mattes:]

Thank you.

[Operator:]

And that does conclude the question-and-answer session. We'll turn the conference back to Mr. Virostek for any additional or closing remarks.

[Stephen A. Virostek:]

I appreciate everybody's time this morning on our third quarter earnings call. If you have follow-up questions, please give us a call at Investor Relations. Thank you.

[Operator:]

That does conclude today's conference. Thank you for your participation. You may now disconnect.