Participants

Christopher Sikora; Vice President - Business Finance Operations; Diebold Nixdorf Inc

Octavio Marquez; President, Chief Executive Officer, Director; Diebold Nixdorf Inc

James Barna; Chief Financial Officer, Executive Vice President; Diebold Nixdorf Inc

Matt Summerville; Analyst; DA Davidson

Matt Bryson; Analyst; Wedbush Securities

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the first quarter 2024 Diebold Nixdorf call. (Operator Instructions)
I would now like to hand this conference call over to our host, Christopher Sikora. Please go ahead.

Christopher Sikora

Hello, everyone, and welcome to our first quarter 2024 earnings call to accompany our prepared remarks, we have posted our slide presentation to the Investor Relations section of our website.
Before we start, I will remind all participants that you will hear forward-looking statements during this call these statements reflect the expectations and beliefs of our management team at the time of this call, but they are subject to risks that could cause actual results to differ materially from these statements so you can find additional information on these factors in the company's periodic and annual filings with the SEC. Participants should be mindful that subsequent events may render this information to be out of date.
We will also be discussing certain non-GAAP financial measures on today's call. As noted on slide 3, a reconciliation between GAAP and non-GAAP measures can be found in the supplemental schedules of the presentation.
With that, I'll turn the call over to Octavio.

Octavio Marquez

Thank you, Chris, and thank you all for joining us today. Before we start the call I just wanted to say thank you to Jim for his leadership as CFO, as we undertook major actions to fortify our balance sheet and improve our financial condition. Jim has played a vital role in strengthening our company, and we're extremely grateful for all of its efforts. I look forward to working with Jim in his new role. We are also looking forward to welcoming Tom Kimco as our new CFO for officially starts on May 17th and years of experience at GE and GM, along with his deep background across key financial discipline will help us build off the foundation we have in place and further strengthen our financial and operational detail.
Now to begin on Slide 4. We are off to a solid start in 2024 with good progress across our operational and financial priorities for the year. The strength of our first quarter positioned us well to achieve our full year expectation as we build upon this quarter. First, we continue winning in the market with our leading sales service and automation technology. Product backlog remained at 1.1 billion at the end of the first quarter, which is consistent with our backlog levels at the end of 2023. We are encouraged by the demand environment, which remains stable and is supporting our product backlog while we have also accelerated rated product revenue growth over the last several quarters. Additionally, we are gaining traction in the market with our managed services offering.
During the quarter, we closed a five year managed service agreement with a top five bank in Western Europe. We continue to believe that banks and retailers are adopting an outsourced service model represents the next wave of service growth, our value proposition of improving operational efficiency and reducing the total cost of operating ATMs and checkout devices. It's resonating well with next, we remain focused on driving innovation and reducing complexity for customers for our recently introduced retail smart vision solution automates self checkout age restricted items for Edah Geiger at the airport, leveraging artificial intelligence and computer vision technology fits up transactions considerably and give employees more time to serve customers. Also, we are running multiple live pilots with global retailers, leveraging our technology to address shrink related issues to checkout we anticipate that over time, our approach to addressing shrink at checkout can be applied to the entire retails or ITO.
On the banking side, we continue innovating and winning with DN Series recyclers. We have recently launched a stand-alone, whether ICN. series recyclers unit in North America that allows banks to continue redefining the branch footprint. Our high capacity, no recyclers specifically developed for the multiple heavy cash usage markets across the globe. It's helping us win new customers. In addition, we simplified our software portfolio, making it easier to deploy an update across multiple hardware and bar, which is expanding our multi-vendor opportunity.
In terms of financial performance, we had another quarter of strong results as our team continued to improve our operational execution higher revenue and our focus on gross margin expansion, combined with the benefit of strong operating expense management is following through to the bottom well results year over year profitability growth and better free cash flow performance. Cash and capital discipline is a focus there. First quarter represents a positive step in better linearity in our historical seasonal cash generation across our operations. We are focused on working capital and asset efficiency to drive higher free cash flow. We included additional information on that topic in our earnings presentation.
Since closing that trade net working capital of EUR379 million. It's 10% of trailing 12 month revenue, representing the second straight quarter of leverage improved. I am proud of our team as we keep building operating momentum and staying focused on delivering for our customers.
Moving to slide 5, we introduced the DN continuous improvement flywheel last quarter will help us better articulate our longer-term objective. We are pleased to see progress in the quarter as we embark on our continuous improvement journey starts with the people who make Diebold Nixdorf a great company. We are investing in our people so we can continue to create leading-edge products and deliver world-class service. We've been successfully onboarded Frank Bauer, Executive Vice President of Operational Excellence earlier in the quarter. We are currently filling roles with experienced lean practitioners and supply chain and service that will accelerate the flywheel of continuous improvement in operational execution. We are strengthening our leadership bench with a clear focus on employee development, we expect our team to deliver profitable revenue growth and gross margin expansion in the first quarter. Innovation and commercial execution led to revenue growth improved year over year. Operating profit was driven by gross margin expansion and operating expense discipline. We are in the early stages of implementing the tools of continuous improvement and lean operation. I am encouraged by the developments we have seen so far. Most notably in manufacturing, our team in North Canton has already identified ways to decrease ACM production time by approximately 15%. This example is just the beginning of what I think is possible across our global footprint as our teams embrace this mindset and identify future projects.
Finally, we are executing on levers to improve free cash flow conversion. We see the opportunity to meaningfully improve over the next 12 to 24 months by driving higher profitability, margin expansion, stronger working capital and asset efficient more restructuring with a strong focus on returns and lowering our debt costs. These are just a few indicators that we are on the right track and making progress on our continuous improvement journey.
Turning to slide 6, I would like to highlight recent performance trends in our regions. In North America, we continue to see strong adoption of cash recycling technology. Additionally, we are seeing improved service performance, which is benefiting from our investments in internal resources and process improvements. As our internal resources are getting more productive, we're moving away from the higher cost third parties used to supplement our work. This is resulting in higher quality service for our customers as well as better service profitability.
In Latin America, we are driving strong revenue growth across both product and service. Cash usage remains strong in the region, supporting demand for our DN Series cash dispensers and recycle service growth is driven by our large installed base with strong recurring contract revenues in Europe banking market remained stable with steady activity across product and service. On the retail side, we continued to grow our installed base of self checkout units under service contract over the past two years, we have basically doubled our self checkout unit shipments annually as European retailers moved quickly to adopt the solution and the vast majority of our shipments represented new placements in the market. As we move into 2024, we expect to continue increasing our self checkout installed base with more potential growth coming from North America in Asia Pacific, Middle East and Africa. Stronger cash recycling trends are developing across the region. We had higher unit shipments in A-Pac for both cash dispensers and cash recyclers in the first quarter. Also, we shipped an additional 1,500 cash units leveraging our India contract manufacturing facility. We are seeing solid activity levels across all our regions, and we benefit from our diversified global base.
With that, I will hand the call over to Jim to go into more details on quarterly results.

James Barna

Thank you, Octavio. Starting on Slide 7, with an overview of our non-GAAP results. The first quarter represents a solid start to the year as we work on linear rising our quarter's revenue of $897 million increased 5.1% and gross margin expanded 290 basis points year over year, primarily due to strong product performance. Included in our product results is a $10 million benefit from a Brazil tax recovery. Normalizing for this item, our gross margin expanded 210 basis points year over year. Gross profit improvement was primarily driven by benefits from our supply chain logistics initiatives, combined with price discipline. And we are also seeing incremental benefits from the recent investments in our service infrastructure.
Operating expense was down 1.9% compared to the prior year period as we improve our operational efficiency. Adjusted EBITDA of $103 million is up 62% compared to the prior year and adjusted EBITDA margin expanded 400 basis points to 11.5%.
Looking at free cash flow, first quarter was a use of $36 million, which was favorable by $65 million year over year, driven by higher EBITDA and better working capital efficiency. On an unlevered basis, free cash flow was slightly positive in the first quarter which is a meaningful achievement given our historical seasonality.
Turning to Slide 8. Banking revenue of 649 million was up approximately 9% versus the prior year period. Driven by product revenue growth of almost 24%. Favorable product and geographic mix primarily drove the year-over-year improvement in product revenue. Service revenue was up approximately 1% versus the prior banking gross profit increased by $40 million year over year to $181 billion. Gross margin was 27.8% in the quarter, which is up 410 basis points year over year. Significant product gross margin expansion was due to greater input cost control and the continuation of price increase realization. It also includes the benefit of the $10 million Brazil tax recovery item I mentioned earlier. Normalizing for this item, our banking gross margin expanded 300 basis points year-over-year.
One last item to note from bank service gross margin was up 190 basis points compared to 4Q 23 has been a focus area for the company, and we expect to see continued improvement going forward.
Moving to Slide 9. Retail revenue of $248 million was down approximately 4.5% versus the prior year as strong service activity was more than offset by our decision to selectively exit lower margin.
Third party hardware sales, both self checkout and electronic point-of-sale revenue was down low single digits compared to the prior year period. Gross margin of 26.2% in the quarter is relatively flat compared to the prior year. However, first margin is up approximately 30 basis points year over year, excluding a onetime nonrecurring benefit in the first quarter of 2023 Sequentially, first quarter gross margin is up 60 basis points, driven mainly by product mix and lower product input costs. As you can see from the five-quarter trend, there was some lumpiness to the retail business, but overall, we are encouraged with the good growth in the service business and the improving product profitability.
On Slide 10. Last quarter, we introduced this information and present a more complete view of the changes in our cash position and highlight our efforts to better linearize the quarters. In the past, we had substantial quarterly volatility in our free cash flow that resulted in significant cash use through the first three quarters of the year before generating free cash flow in the fourth quarter.
Now the company is in a better position to manage free cash flow more efficiently through improved commercial and operating rigor. You can see evidence of our progress in the first quarter with free cash flow improving $65 million compared to the prior year period. And the first quarter, cash and short-term investments were $407 million, which includes the impact of our 200 million debt paydown in February. Net leverage remained at 1.6 times, which is consistent with year end 2023.
Now I will turn the call back to Octavio.

Octavio Marquez

Thank you, Jim. On Slide 11, we are reiterating our previously communicated 2024 performance outlook. Given the strength of our first quarter results and improved operating momentum, we are well positioned to deliver on our full year expectations. We expect to profitably grow revenue and adjusted EBITDA is expected to be in the range of $410 million to $435 million.
Looking at the adjusted EBITDA quarterly cadence for the year, we now expect the first half of the year to be approximately 45% to 50% of full year adjusted EPS. This update reflects a stronger initial improvement from our efforts to linearize the year more we are targeting free cash flow conversion of greater than 25% of adjusted EBITDA in 2024.
And additionally, looking beyond 2024, we are working to deliver free cash flow conversion of greater than 50% of adjusted EBITDA. We expect to achieve greater conversion by driving higher profitability through revenue growth and margin expansion, continued working capital efficiency, consistent capital expenditure outlays bore restructuring with a strong focus on returns and lowering our debt.
To wrap things up on slide 12, we have lots to be excited about at Diebold Nixdorf moving into 2024. There is no doubt we are on now a stronger company, a more focused company and have established our operating momentum throughout the last three quarters. We believe there are highly attractive and potentially under appreciated aspects of Diebold Nixdorf value creation story that make for a compelling investment thesis at current trading levels built around four components.
First, we have strong visibility into our business with solid banking and retail assets. Our product backlog of approximately 1.1 billion provides good coverage for product revenue for the remainder of the year. Also, approximately 70% of our total higher-margin service revenue is recurring, which provides additional stability and predictability into our top line performance.
Second, we are accelerating gross margin expansion with our continuous improvement program and maintaining operating expenses. We know the company has opportunity rich, and as we implement these tools and actions, we will improve our overall profitability.
Third, as we outlined on the call today, we have a number of levers available to us to meaningfully improve cash flow generation. The path is clear, the teams are aligned and now we must capture these events. And fourth, we are in the early stages of developing a value-creating capital allocation strategy that will benefit all our stakeholders as free cash flow conversion continues to improve, we will invest in the business and unlock additional value for our stockholders.
This is the next stage of our value-creation story. I look forward to sharing more details with you as we solidify our future capital allocation priorities with the Board.
And with that, operator, please open the call for questions.

Question and Answer Session

Operator

(Operator Instructions) Matt Summerville of D.A. Davidson.

Matt Summerville

Thanks. A couple of questions. Can you maybe delve a little bit deeper into some of those specific actions you've taken to drive better linearity across the business in and also touch on why we should view that as sustainable?

Octavio Marquez

Sure, Matt, thank you. So value or so. So if you recall, I've been talking about miniaturizing our business for multiple quarters now. So I would say the most important step that we've taken is how do we manufacture and deliver to customers more efficiently and how do we align better to their installation schedules. This actually helps us both in manufacturing and service as we can more accurately predict the needs of the customers our own capital needs to deliver to them.
So I will tell you that this is still work in progress. We are very pleased with the results in Q1. We are now working on how do we keep linear. I think the middle half of the year, as you know, Q4 will always be the largest quarter as just the trends in the business. But you know, Q1 was bigger than Q1 of prior year as a percentage, the middle quarters, we're expecting to see that continues improvement in linear, I think and then that de-risks significantly our Q4 as we deliver this, we will have a smaller Q4 as we deliver more linear quarter. So every quarter you should expect to see improvement at. But that's kind of we're feeling about it. And we do feel that with this continuous improvement and all the actions that we're taking, these actions will be sustainable for the future.

Matt Summerville

And then excuse me, as a follow-up, can you touch on sort of the sustainability in product gross margins, setting the $10 million benefit from Brazil aside. And similarly, I want to talk about service in the context of historically speaking, Q1 would sort of serve as the low or kind of jumping off point for service gross margins to build throughout the year into a bigger fourth quarter. Is that still the case in terms of how we should be thinking about our service margins ramped throughout the year.

Octavio Marquez

So let me start with product, Matt. So we are convinced that our margins are sustainable. Clearly, there might be small variations of that quarters based on on volume and mix what we think that the actions that we've taken around our supply chain and our own pricing discipline will work keep our margins at this level. So I do believe that this sets the sustainable level.
More importantly, one of the changes that we're making in the Company is there's no program or one action that we're embarking on to deliver on a particular quarter. We're focused on this continuous improvement journey that we're in. So as we deliver on margins one quarter, that team is already working on, what can we do to do better next quarter. So I would say that this is the mentality that we're working on. We know that there will always be headwinds and opportunities, but the teams are focused on continuously improving the results that they're delivering.
On the service side, we've made significant investments in improving quality and our service, and I'm very pleased on the results that we have. Speaking to our North America customers. They all recognize the significant changes that we've made and how that is helping them better manage their ATM fleet. So I'm very pleased with that. We made significant progress in Q1 as compared to Q4, and our goal is to continue making progress throughout the year. So you should expect us to continue improving margins. You know, every quarter of the year as we move forward in our service operations.

Matt Summerville

And then just lastly, I'll sneak in one more for Jim, if you could. Can you kind of give us the EBITDA to free cash flow sort of walk through as you guys see it for the year in kind of a similar fashion to what you provided on slide 10 for Q1 if you can just kind of fill in the blanks a little bit in terms of how we get to the 1.5 midpoint from we have what is of $420-some million midpoint on EBITDA?

James Barna

Yes. Thanks, Matt. I would say that that largely is in line with we had talked about when we came out with guidance for the year save for. And I think you can see what drove what drove the first quarter favorability against the prior year are just all the on the benefits that we're starting to see from more efficient working capital management.
So I'd say all of the other points and bridging items that we gave at that point in time remain intact, particularly around things like taxes and restructuring efforts and those things where we're starting to see maybe a little bit more benefit through the operations and more diligent into an efficient working capital management. We saw with inventory here in the first quarter. We expect to continue to see that through the through through the balance of the year, that efficiency and you can see from our receivable metrics that there's a little bit of opportunity there for us to go get so hard. Yes, that's that's really the key variable there is that working capital benefits coming through Got it.

Matt Summerville

I'll get back in queue. Thanks.

Operator

Matt Bryson, Wedbush Securities.

Matt Bryson

Thanks, for taking my questions this morning. Congrats on the strong results and the progress in moving towards that more linear shipment profile that you've been targeting. And I know of course, can fluctuate a bit, but I thought it was particularly impressive that you managed to hold backlog steady despite the better sales number.
And I'll tell you, I think you characterize the environment stable. But again, this is better than I would have thought given the better sales number, was there anything unusual going on in terms of like large contracts that you added on or have you seen any improvement in customer activity and that would explain kind of why you're seeing better sales, but also, again, not working through backlog anymore.

Octavio Marquez

So but thanks, Matt again, I think that when I walked you through the different regions, you can see that there's still enough strength in the North American market as recycling continues to take hold. Latin America has always been a strong market for us. And in Europe, I think I mean a little even though our retail revenue fell a little bit short this quarter from the prior year.
It was a conscious decision that we made on exiting certain unprofitable third-party sales that we didn't really contribute much to us. But I would as I said, I characterize demand as stable. We continue winning. And I think that this is a trend that the teams are very focused on. We've built a strong base with recyclers. We have good technology that customers want to adopt.
And on the retail side, we're now very focused on over the past two years, we've grown significantly in Europe. We've made our first inroads into the U.S. market. And this is the year where we're really focused on how do we accelerate our expansion into the U.S. So I would tell you that those are the kind of the key drivers, but particularly it's a strong focus of our teams to keep winning in the market and serving our customers.

Matt Summerville

Awesome. The gross margin improvement in the quarter was nice to see. And I know you talked about the ability to continue to improve that metric. At the same time you're keeping your EBITDA and free cash flow guidance unchanged. Were the improvements that you're seeing or I think that you can manage already envisioned when you provided your initial guide? Or can we assume that you execute in terms of getting gross margin higher and that we'll see upside assuming all else is unchanged.

Octavio Marquez

Yes, Matt. So so clearly, we had built some of these things into our planning. I would say, particularly we're seeing faster return on some of the actions that we took, particularly on the product side, we do see component pricing working favorably, pricing, taking hold in our across our enterprise with all our sales teams. So some of those benefits that we were hoping would be more Q2, Q3.
We're realizing before we need to maintain those improvements throughout the year, and we're confident that we can do that before we change anything, we want to make sure that we provide the norm consistent operational execution over the coming quarters. We still we still need to linearize more of the quarters. As I said at the beginning, we are off to a good start now. We're working on a strong Q2, a strong Q3 and taking risk off the table as long as we keep linearize and things. But that is the that is the spirit. And as we do that, yes, clearly we will have opportunities to keep improving throughout the year.

Matt Bryson

Excellent. Thank you so much for your time and you answered my question.

Operator

Matt Summerville, D.A. Davidson.

Matt Summerville

Just two quick ones. Maybe Octavio, can you maybe describe and the recycling adoption level you're seeing in North America? Is it still primarily relegated to the largest kind of Tier one financial institutions. Are you starting to see that migrate down market into the small bank regional bank market? In addition, if you could maybe use a baseball analogy in line to describe where we're at with recycling adoption in North American and how that how that will likely play out, but this year and heading into 25?

Octavio Marquez

Yes, Matt. So so again, as you know, and you know, though, the large banks have started on that journey. But I would say that we're still in the early innings with those large banks. I know we've had significant wins in Q1 with large banks that are just starting down that journey. Remember recycling it provides better customer service, but clearly a lot of operational efficiency.
So as these larger banks start adopting this. And remember, they need to change part of their software and different things that provide other opportunities for us as these banks mature in that journey I think it's still multiple years. They're large fleets to refresh, but clearly smaller financial institutions take note of that.
And remember, in particular in the US market, many of the smaller financial institutions are connected to large national switches, which are all investing heavily in building recycling capability. So I would say that we're very early in the stages of adopting recycling. We're also seeing recycling, not just at the ATM, I think of our recently launched seller cash recycler, which is starting to gain traction as part of the whole cash ecosystem that you have in a branch, which is a very important point. You know, recycling provides benefits not just at the ATM, but at the whole branch level. So I would say that we still have significant runway to go. But it's so it's a it's a process we need to switches to adjust to recycling. The big banks are doing it on their own. So we see this as well as the early stages of our process work, probably still in the early innings of doing this.

Matt Summerville

Got it. And then as a follow-up, can you just put a finer point on the headwind we should expect in 2024 overall from some of that deliberate revenue exit that you guys undertook in the retail business and can you maybe just put a little bit of finer point on exactly well, how that relationship would have worked in the past? Just a little bit more around exactly what you exited there?

Octavio Marquez

Yes. So Samad, I once I think the important part is we're very focused on ours. We still believe, Scott, it's a great avenue of growth. You know, I have no doubt of that, retailers are facing some of the same challenges and want to continue investing in those technologies. And we are developing the complementary solutions as our shrink solution. Our age verification solutions to make the solution even more robust in the channel.
In the past, as we look at a retail environment, we were selling third party products into many of these large retailers, think about electronic shelf labels that we would integrate handheld scanners, different products that were part of providing a service to a customer. But we were just basically being a reseller for somebody else. So we've made the decision that it's better to utilize our cash in different in different ways. I would say that this while it be a revenue headwind you can see we will be a profitability increase for our retail business. So that's why we're focused on that. I think overall, the growth in school and electronic point of sale throughout the year will more than offset that that decline in those third party sales. So we do see, you know what stable retail business, but with a much better product mix Got it.

Matt Summerville

Thank you.

Operator

Matt Bryson, Wedbush Securities.

Matt Bryson

Thanks for taking a follow-up on to free cash flow and with the solid operating profit and the like, the There doesn't seem to have been any headwinds from inventories or accounts receivable or working capital at all. And so a lot of reasons cash flow was negative was that was in other categories, Jim, you mind just walking us through what exactly was what that other category is and that led to free cash flow being negative?

James Barna

Yes, I would say, Matt, thanks. Thanks for the question. And again, I think we talked about this at year end with respect to how we and how we group cash flow items. And so I think the incremental disclosure that we've given in the deck breaks apart, how we look at working capital. And so what portions of current liabilities and current assets are outside of what flows through those receivables, payables, inventory, deferred revenue lines.
And so the biggest, the biggest driver of the other category here in the first quarter is timing on indirect tax payments. And so if we think about the fourth quarter and we typically have timing items to the to the positive in terms of sources and then that flips around in the first quarter here where the ad where the cash goes ad goes out. So that's really the most significant item of that. And then the balance is made up of other movements on accruals and prepaid timing at the beginning of the year.
As you can see that actually in the new table that we put into the deck and towards the back, it's a supplemental schedule, Matt, but it should be helpful in bridging some of the incremental items outside of AR inventory, AP and deferred revenue that give rise to those movements. So the biggest item there is indirect taxes, followed by other timing on a full payments that get paid out of accounts that are not categorized within accounts payable.

Matt Bryson

Got it. But it sounds like it's predominately timing time, timing items as opposed to anything structural.

Octavio Marquez

So Mark, net, those are bad debt if you are able. And that's right. That's right. And okay.

Matt Bryson

And then I guess just one last question for me, and I know that the some circumstances around the debt forced you guys to give us unit estimates it doesn't look like you're disclosing those anymore for ATMs, self-checkout point of sale. I'm not going to see those at all or will we see those filings or if we're not going to see them. Can you give us I don't know some our guidance around sequential or rough rough numbers or any help there. Thanks.

Octavio Marquez

Yes, Matt. So I would tell you that we're moving away from units that were more focused on price realization that we get and kind of volume mix across the different regions. But what I what I would tell you is we still see for ATM units and sold units, particularly in APM. We're entering new markets. We're reentering the Indian market. So we do expect to see growth in bulk in volumes across the across our geographies. So I would say that we will move away from that and be more focused on clearly the revenue mix and margin and margin expansion of our products.
That is, I think, a better metric for us to focus on. And again, as we linearize quarters, which is the most important thing to me, we will be you will see that Q2 will be better than then Q. one Q. three will be a little bit better and then Q4 will be a more manageable and not so dependent for our yearly results. So say that both important thing is we still see growth in units, but were linear. I think that more across across the year so that we don't have that big spike in Q4.

Matt Bryson

Thanks for that.

Operator

Thank you. And this concludes our Q&A session. I'd like to hand the conference call back over to Christopher Sikora for closing remarks.

Christopher Sikora

Thank you for participating in today's earnings call. Please feel free to reach out to me Chris Sikora in Investor Relations if you have any questions or need additional information. Thanks again, and have a good rest of the day.

Operator

Ladies and gentlemen, thank you for joining today's call. You may now disconnect your lines.