DIEBOLD NIXDORF, Inc quarterly report, Q3 FY2018

Diebold Nixdorf, Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2018; unaudited interim results. Diebold Nixdorf provides connected-commerce hardware, software and services for banking and retail customers, with reportable segments of Eurasia Banking, Americas Banking and Retail.

Key Financial Metrics

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Net sales	$1,119.0 million	$1,122.7 million	$3,288.8 million	$3,359.4 million
Gross profit	$228.3 million	$240.0 million	$687.7 million	$718.3 million
Gross margin	20.4%	21.4%	20.9%	21.4%
Operating profit (loss)	$(133.9) million	$(8.6) million	$(287.6) million	$(89.3) million
Operating margin	(12.0)%	(0.8)%	(8.7)%	(2.7)%
Net loss attributable to Diebold Nixdorf	$(212.6) million	$(36.0) million	$(423.2) million	$(126.7) million
Diluted loss per share	$(2.79)	$(0.48)	$(5.57)	$(1.68)

Q3 revenue was essentially flat year over year, including a $26.1 million unfavorable currency impact; constant-currency revenue increased 2.0%.
Nine-month revenue declined 2.1%, while reported results benefited from a $94.9 million favorable currency impact. Services represented $1,769.6 million, products $1,156.4 million and software $362.8 million.
Q3 operating expenses included a $109.3 million non-cash goodwill impairment charge. Nine-month impairment charges totaled $199.3 million, including $90.0 million in Q2.
Interest expense increased to $45.2 million in Q3 and $99.6 million for nine months, compared with $27.7 million and $90.7 million, respectively, primarily because of higher debt and interest rates.
Cash used in operating activities was $372.1 million for nine months, compared with $235.3 million used in the prior-year period. Inventory increased to $846.5 million from $728.9 million at December 31, 2017.
Capital expenditures were $40.5 million. Investing activities provided $90.1 million, primarily reflecting investment maturities and proceeds from asset sales.
Cash, cash equivalents and restricted cash totaled $443.7 million at September 30, 2018, including $304.4 million of unrestricted cash and $139.3 million of restricted cash.
Total debt, including current notes payable and net of deferred financing fees, was approximately $2.39 billion, compared with $1.85 billion at December 31, 2017. Long-term debt was $2.337 billion.
Total reported cash availability was $593.5 million, consisting of cash and cash equivalents, short-term investments, $44.1 million available under uncommitted lines and $240.0 million available under the revolving facility.
Shareholders’ equity attributable to Diebold Nixdorf was negative $7.4 million at September 30, 2018, compared with $464.6 million at year-end 2017.

Material Changes Versus the Prior Comparable Period

Eurasia Banking revenue declined 5.8% in Q3 and 4.8% for nine months, primarily from contract roll-offs, lower product deployments and weaker activity in several markets. Its Q3 segment operating margin improved to 9.9% from 8.7%, but the nine-month margin declined to 6.1% from 6.6%.
Americas Banking revenue increased 1.5% in Q3 but declined 3.7% for nine months. Segment operating margin fell to 1.0% from 3.8% in Q3 and to 1.0% from 4.3% for nine months, reflecting unfavorable mix, Brazil costs, supply-chain delays and lower maintenance revenue.
Retail revenue increased 6.1% in Q3 and 4.3% for nine months, supported by kiosk and POS projects, but operating margin declined to 6.4% from 9.6% in Q3 and to 4.1% from 8.3% for nine months.
Gross margin declined 100 basis points in Q3 and 50 basis points for nine months. Product and software margins were pressured by customer mix, freight costs, lower-margin licenses and professional services.
The Company reorganized its reporting structure around Eurasia Banking, Americas Banking and Retail beginning in Q2 2018 and reclassified prior periods for comparability.
The Company adopted the revenue recognition standard ASC 606 on January 1, 2018 using the modified retrospective method. The adoption increased opening retained earnings by $4.6 million and affected the timing and classification of certain revenue, inventory and deferred revenue balances.
A prior-period error in repairable service-parts inventory was corrected retrospectively; management determined that the correction was not material to prior periods.

Guidance, Outlook and Management Commentary

Management launched the DN Now transformation program, including a customer-centric operating model, services modernization, supply-chain improvements, portfolio optimization and cost reductions.
DN Now has a stated savings target in excess of $250 million, with approximately $100 million expected over the following year. The filing also states that restructuring-related savings under the new operating model were expected to be approximately $130 million.
The Company recorded $44.4 million of restructuring charges during the first nine months, including $38.3 million related to DN Now, and expects approximately $90 million to $110 million of additional DN Now restructuring costs through completion of the transformation.
Management expects capital resources to be sufficient for planned needs for at least the next 12 months, but operating cash flow was materially negative and liquidity declined sharply from year-end.
In May 2018, the Company suspended quarterly dividends and redirected funds toward debt reduction and other capital needs. No Q3 dividend was declared or paid.
On August 30, 2018, the Company raised $650.0 million through a new Term Loan A-1 Facility. Proceeds were used for debt repayments, a reduction in revolving commitments, purchases of Term Loan B debt, funding the acquisition of remaining Diebold Nixdorf AG shares and general corporate purposes.
The Company owned approximately 93% of Diebold Nixdorf AG at September 30, 2018 and initiated procedures to acquire the remaining shares and merge the German subsidiary into Diebold KGaA.

Risks, Contingencies and Unusual Items

Debt is highly leveraged and secured by substantially all assets of the Company and certain domestic subsidiaries. The Term Loan A-1 carries a margin of LIBOR plus 9.25% and matures in August 2022. The Company was in compliance with its debt covenants at September 30, 2018, but covenant thresholds become more restrictive over time and covenant reset triggers may apply.
Goodwill impairment testing identified no excess fair-value cushion for Eurasia Banking, EMEA Retail and Rest of World Retail. Changes in forecasts, discount rates, terminal growth rates, market multiples or execution could result in additional impairment.
The Company increased its provisional Tax Act transition-tax estimate by $46.8 million. Accounting for the Tax Act was incomplete at quarter-end, and final amounts could differ materially.
Material indirect-tax contingencies had an estimated aggregate risk of up to $125.8 million. The Brazil matter had a $4.0 million accrual and could be material if resolved unfavorably. Thailand customs matters remained subject to appeals, with no accrual recorded.
Minority shareholders challenged the adequacy of compensation under the German domination and profit-transfer agreement. The potential loss or range of loss could not be reasonably estimated.
Guarantees and standby letters of credit had maximum future payment obligations of $157.6 million, with no associated liability recorded.
Foreign exchange, interest-rate, supply-chain, customer spending, cybersecurity, competitive, regulatory, pension and integration risks remain significant. Argentina was treated as highly inflationary during Q3 2018.

Investor Verification Points

Verify the Company’s ability to convert the reported DN Now savings targets into sustainable operating cash flow and margin improvement.
Monitor operating cash flow, inventory reduction, working-capital normalization and the decline in available liquidity.
Reconcile total debt, borrowing costs, covenant headroom and the consequences of the Term Loan A-1 covenant reset triggers.
Assess the likelihood of further goodwill impairments, particularly in reporting units with no valuation cushion.
Track completion and funding of the Diebold Nixdorf AG squeeze-out and the outcome of related appraisal proceedings.
Review final Tax Act accounting, indirect-tax contingencies and other potential cash obligations.
Confirm whether segment revenue and margin trends improve after supply-chain remediation, services modernization and the Windows 10 upgrade cycle.