Diebold Nixdorf Inc (DBD) 2020 Q3 法說會逐字稿

Good day, and welcome to the Diebold Nixdorf hosted third quarter 2020 earnings call. At this time, I would like to turn the conference over to Mr. Steve Virostek. Please go ahead.

Thank you, Olivia, and welcome, everyone, to Diebold Nixdorf's third quarter earnings call for 2020. Joining me today on the call are Gerrard Schmid, President and Chief Executive Officer; and Jeff Rutherford, our Chief Financial Officer.

To accompany our prepared remarks today, we have posted slides to the Investor Relations page at dieboldnixdorf.com. Later this afternoon, a replay of this webcast will be available on the IR website.

Slide 2 contains a reminder that today's comments will include non-GAAP financial information, which we believe is helpful in assessing the company's performance. In the supplemental schedules of our slides and the earnings release, we have reconciled each non-GAAP metric to its most directly comparable GAAP metric.

On Slide 3, we remind all participants that certain comments may be characterized as forward-looking statements and that there are a number of factors, which could cause actual results to differ materially from these statements. Additional information on these factors can be found in the company's SEC filings. Participants should be mindful that our forward-looking information is current as of today, and subsequent events may render this information to be out of date.

And now I'll pass the microphone to Gerrard.

Good morning, everyone, and thank you for joining us. I am pleased to join you today to discuss another solid quarter of financial results as we continue to deliver progress against our plans and demonstrate the resiliency of our model. I am pleased with how our business is performing, especially in the face of a dynamic and highly uncertain macro environment, characterized by rising infection rates and lockdown restrictions in certain markets. Our company has learned how to manage through these challenges and support our customers.

Against this backdrop, we will continue to execute on our strategy and are confident in our ability to advance the business in 2021. I'll discuss this further in my remarks today.

Let me begin on Slide 3 with our key messages. Business activity improved in the third quarter as we continue to deliver essential solutions for financial institutions and retailers. We delivered solid year-on-year and sequential improvements to orders, led by a strong rebound in order activity for our products as customers continue to value our latest ATMs, self-checkout and point-of-sale devices. Revenue also improved as the global economy began to recover from a difficult second quarter, and installation activity experienced fewer and less impactful delays. I am incredibly proud of how our teams have responded to the challenges of this year. Our ability to manage through a difficult time provides us with confidence as we work through the next wave of the pandemic.

In the quarter, we again expanded profit margins, mainly through our continued execution of our DN Now initiatives. And once again, we're reporting strong year-on-year increases to gross profit, operating profit and adjusted EBITDA, all while delivering solidly for our customers.

With a solid backlog and operating momentum, we are tightening our 2020 outlook to the high end of our prior range. We're looking forward to a solid fourth quarter despite the tough year-on-year comp. And looking into 2021, our focus will be on the continued resiliency of the organization and a balance of improved free cash flow conversion and top line growth.

On Slide 4, I'll discuss our third quarter results. We increased our backlog by 9% in the quarter on the heels of strong order growth of 7% during the third quarter, with broad-based gains in both banking and retail. In our banking business, our customers have strongly reinforced the strategic relevancy of their self-service channels, and we're benefiting from ongoing investments as banks upgrade their self-service capabilities with heightened interest in cash recycling, automated deposits and cardless transactions. We experienced broad-based order growth across our banking segments, especially as we book orders for our next-generation DN Series ATMs, including orders from a top 10 bank in the U.S., a top 5 bank in France and a large order in Egypt.

In the retail segment, customers are investing in automation and greater self-serve capability. We are seeing strong demand for our modular, open architecture, self-checkout solutions, which improve the in-store experience with faster, low-touch transactions. These solutions benefit retailers through higher checkout availability and lower operating costs.

During the fourth quarter, we secured a milestone new self-checkout deal with a pan-European grocery store operator, who operates the second largest fleet of self-checkout devices in the world. Our 5-year agreement consists of providing approximately 14,000 self-checkout devices and providing related services at approximately 6,800 locations. This is the largest self-checkout win in the company's history. This win builds on our third quarter success, which included a number of wins at one of the largest supermarkets in Germany, totaling $19 million for point of sale, self-checkout and electronic shelf labeling solutions. We also booked a new $7 million contract with a U.S.-based discount retailer for self-checkout products and cash management software. Because of the strong business case for self-checkout and low penetration rates globally, we believe the secular growth trend will continue for several years.

Another important win in retail was a new software opportunity, valued at approximately $6 million with a global fuel and convenience company, which will benefit more than 900 stores in the United Kingdom and South Africa.

We are also pleased with new service contract wins in the quarter. We signed new contracts to service approximately 8,000 ATMs in Italy and 4,000 units in Thailand. Our contract with the Thai bank also includes a refresh of all ATMs plus software and professional services. In the United States, we signed a $3 million managed services contract with Truliant Federal Credit Union for end-to-end managed services of their ATM channel.

Changing over to our top line results. We delivered a sequential revenue improvement of approximately 12% in the quarter to $995 million or a 5% constant currency year-over-year decline were normalizing for divestitures. Revenue improvements were driven by 3 factors: firstly, an easing of unplanned reductions, which includes delays caused by the COVID-19 pandemic. Secondly, a weaker U.S. dollar, which provided a 1% tailwind versus the prior year period; and thirdly, diminishing account rationalization activity, which is now largely behind us.

Let me now summarize our progress on Slide 5 on our transformation journey that we launched in mid-2018. At that time, we set out to simplify and streamline our business, our solutions and the way we conduct business in order to drive stronger profits and more sustainable cash flows. We have been driving higher-quality revenue through disciplined sales pursuits by rationalizing low-margin business and through a series of noncore asset divestitures. At the same time, we launched about a dozen work streams under the DN Now umbrella, designed to scale our business, deliver higher gross profit margins and reduce operating expense.

The chart on the right illustrates our progress. Over the past 2 years, we've increased our trailing 12-month adjusted EBITDA by more than 50% from $301 million to $456 million. And we've expanded our adjusted EBITDA margin by 5 full percentage points to 11.6%. In doing so, we've transitioned the company to a value creator, whereby our return on invested capital exceeds our weighted average cost of capital. This work has also driven substantially higher resiliency in our overall operating model and our ability to weather the challenging environment.

Moving to Slide 6. Our execution of our DN Now initiatives and higher quality revenue is driving meaningful profit margin expansion. Non-GAAP gross margins expanded 310 basis points during the quarter to 28.6%, led by strong gains in software and services. Our operating profit margin expanded by 280 basis points versus the prior year. And while Jeff will have more details on these financial results, I'm pleased to report that these results are aligned with our framework provided at the beginning of the COVID crisis, namely that we expect to steadily improve our profit margins despite revenue pressure in 2020.

On the right of this slide, we list the key DN Now activities that we are currently focused on that will drive current and future cost benefits. First, our digital transformation initiatives have kicked into high gear as we define key work streams across IT, HR and finance during the quarter with our partner, Accenture. On the SG&A front, we continue to make good progress on streamlining our procurement third-party spend by about 10% year-on-year, closing underutilized real estate offices and transforming our enablement functions. Third, our software excellence activities are exceeding expectations as we generated best-ever gross margins of 49.7%, led by better utilization of our professional services, streamlining third-party labor and more cost-effective global delivery services.

Equally as important, we continue to build momentum with DN Series ATMs. I'm pleased to report that we have completed over 110 DN Series bank certifications and anticipate hitting critical mass shipments in 2021. Our next-generation machines are performing exceptionally well relative to the competition and our prior models. As a result, we are pleased with order growth and a sales pipeline, which is building nicely.

By virtue of the progress in our DN Now program, we're increasing total savings targets from $470 million to approximately $500 million through 2021, with the incremental savings coming from -- primarily from software, services and G&A efficiencies.

Moving now to Slide 7. Earlier today, I referenced that our focus was increasingly shifting to a balanced agenda. This slide highlights some of the key elements of our digital strategy that underpins our belief that we're well positioned to be competitively differentiated as we move into 2021. These digitally enabled assets sit at the center of our strategy to expand revenues looking forward.

We are bringing digitally enabled hardware, services and software to our customers, which meets their demand for greater flexibility and optionality to meet the demands of the market, vast improvement to performance levels and a more scalable cost structure. Our investments in the areas such as our digitally enabled service offering, the AllConnect Data Engine, allow us to deliver step changes in functionality and value and is one of the main reasons why we're energized by our future growth opportunities.

Our digital strategy extends to our own internal capabilities too, to ensure we become more efficient and deliver better capabilities to our employees. Across finance, IT, HR and sales, we're deploying digital tools to enhance our operating efficiency through the use of cloud-based applications, self-service portals and automation.

A tangible example of our digitally enabled solution is on Slide 8. We are building on a strong foundation we've created for our services business. Two years after launching our services modernization program, we are leveraging best practices in order to achieve higher service levels for customers and greater scale for the company, which can be clearly seen in the gross margin improvement of nearly 600 basis points. Looking ahead, we see further opportunities to drive greater value for our customers and shareholders.

Our digital strategy sits at the core of this next leg. Our goal is to connect distributed devices to our cloud-based analytics engine, which we call the AllConnect Data Engine. This applies to both our banking and retail businesses. By correlating and analyzing machine performance data, we can significantly improve the performance of our machines and customer satisfaction by reducing failure rates, by optimizing the use of our service technicians, by increasing the efficiency of our spare parts inventory and by maximizing system availability.

We recently announced the success we're having with remote incident resolution and increased availability at co-ops 2,600 food stores in the United Kingdom. Over on the banking side of our business, we have connected about 55,000 ATMs globally, and 25,000 this year alone. And we're seeing meaningful reductions in the number of site visits for each machine connected to the cloud. Our intent is to leverage the AllConnect Data Engine to make services a more data-driven business, and we expect further improvements to our gross services margin. As a result of this progress, we are raising our long-term services target margin from a year-to-date level of around 29% to a range of 32% to 33% by 2023.

With that, I will hand the call to Jeff Rutherford for a deeper dive into our financial performance.

Thank you, Gerrard, and good morning, everyone. As usual, my prepared remarks today will focus on non-GAAP metrics, unless otherwise noted.

Before we review our operating results, I would like to take a moment to clarify 2 nonoperating topics, which generate investor questions: non-GAAP adjustments and the accounting for our recent debt refinancing.

We all know that when companies transform and restructure, there are a number of actions which can result in nonrecurring accounting adjustments. As summarized in Note #1 of our earnings release, the reconciling items impacting adjusted EBITDA fall into 2 categories. The first is restructuring and transformation costs. Restructuring costs are primarily severance associated with streamlining the workforce, while transformation costs are payments to third parties to implement the structure and process changes associated with our cost elimination programs. The second is nonroutine expenses, which relates to balance sheet and contract cleanup of legacy issues and costs associated with divesting noncore businesses.

Our nonroutine adjustments have largely concluded, with the exception of the occasional divestiture costs. In fact, during the third quarter, nonroutine expenses were $3.5 million and reflected approximately $7 million of divestiture-related costs, offset by $3.5 million of non-U. S. governmental subsidies related to COVID-19. We do not expect both subsidies to reoccur.

As for the DN Now restructuring and transformation costs and payments, they will be winding down and coming to an end in 2021. In fact, the expense recognition of restructuring and transformation costs will be coming to an end sooner, with payments taking longer based on severance payment schedules. As a result, we expect restructuring and transformation payments for 2021 to be in the range of $40 million to $50 million. While this estimated spend is higher than what we originally targeted for 2021, these payments are driving incremental cost savings.

With respect to our refinancing in July, we extended our 2022 maturities to provide additional time for the model to generate incremental value through continued expansion of operating margins. This will create a more favorable environment and potential ratings improvement, enabling us to optimize our long-term capital structure. We incurred incremental costs to effect this extension, and concluded that the benefits, particularly the future flexibility, justified those costs.

Our transaction-related costs were as follows: a make-whole premium to retire Term Loan A-1 debt of $67 million is included in our third quarter GAAP interest expense; a write-off of $26 million of deferred financing fee associated with the retired debt was also recorded as interest expense in the third quarter; additionally, we paid $31 million of transaction fees, which have been capitalized, and will be amortized over the next 5 years and expensed as interest.

Now let's review the operating results. Slide 9 compares our third quarter P&L results to the prior year period. Total revenue, adjusted for divestitures and foreign currency, declined $53 million or 5%. Unplanned headwinds, including delayed installations related to COVID-19, impacted revenue by approximately $68 million and were partially offset by growth of $19 million. Despite lower revenue, gross profit increased approximately $9 million to $285 million, as our DN Now initiatives drove a gross margin increase of 310 basis points.

Operating expenses declined $14 million, including an unfavorable $5 million variance from our performance-based incentive plan. Operating profit increased $24 million versus the prior year to $90 million in the third quarter, a 9% operating margin. Adjusted EBITDA of $113 million increased $15 million or 15% over the prior year period, and our adjusted EBITDA margin expanded by 230 basis points in the quarter to 11.4%. Just as important, the company continues to create value by delivering return on invested capital in the mid-teens, which is greater than our weighted average cost of capital of approximately 10%.

Slide 10 provides additional details on the year-over-year change to revenue. The unplanned reductions primarily affected our product and services revenue, while the incremental business was generated by product and software sales. Unlike recent periods, foreign currency was a benefit this quarter, favorable by approximately $5 million, reflecting a weaker U.S. dollar versus the euro and a strength versus the Brazilian real.

On the right side, we break out the components of our gross margin improvement, which increased by 310 basis points year-over-year despite revenue headwinds. We realized strong gross margin gains from our software and services business, while we maintained the profitability of our products business. Our software gross margin increased to 49.7%, which is mostly attributable to software excellence, our software excellence program, including higher utilization of software architects and lower cost delivery servers. As Gerrard mentioned, our services modernization activities continued to bear fruit, and the team improved service gross margins by 230 basis points versus the prior year. Unlike our second quarter results, margins did not meaningfully benefit from lower activity as service call rates returned to normal levels.

Our next 3 slides contain segment-level financial information adjusted for the effects of divestitures and foreign currency.

Eurasia Banking highlights are on Slide 11. Third quarter revenue declined by $17 million to $364 million after adjusting the prior year period's results for $36 million from divestitures and $12 million benefit from foreign currency. Unplanned reductions, including lower installation activity due to COVID-19 accounted for $38 million of the year-on-year variance. Incremental business of $22 million partially offset the decline. Non-GAAP gross profit of $112 million generated gross margin expansion of 90 basis points to 30.8%.

On Slide 12, Americas Banking revenue was $368 million for the quarter, down $18 million after adjusting the prior year period for $17 million of foreign currency headwinds. Nonrecurring projects drove $12 million of the variance, while $5 million was due to unplanned reductions, including the effects of COVID-19. Lower product volume in the quarter offset software growth occurring at large U.S. financial institutions.

Despite the revenue headwinds, segment gross margin increased by more than 300 basis points versus 1 year ago to 28% due to solid execution of the services modernization and software excellence initiatives.

On Slide 13, retail segment revenue of $263 million declined $17 million or 6% in constant currency. This primarily reflects the impact of approximately $25 million of unplanned revenue reduction, which is masking growth from our self-checkout solution. Foreign currency accounted for a positive variance of approximately $10 million in the quarter versus the prior period.

Our retail team delivered strong gross margin expansion of approximately 470 basis points versus 1 year ago, coming in at 26.3%. Our improvement reflects solid progress with our services modernization and software excellence programs as well as a favorable customer mix in EMEA.

Slide 14. On Slide 14, we compare our year-to-date free cash flow performance with the prior year period. Consistent with prior periods, we define this non-GAAP financial measure as net cash provided by operating activities from continuing operations, excluding impact from assets held for sale and settlement of nonoperating hedging derivatives, less capital expenditures.

Although cash use increased year-to-date, our results are tracking in line with our pre-COVID model. Net working capital accounts for virtually all the variance versus the prior period. You may recall that in 2019, we were harvesting net working capital, which creates a difficult comparison. In 2020, our teams have done a good job managing payables and inventory. While we believe there is some opportunity to improve payables, we have reached an inventory level, which cannot be significantly improved without impacting customer service levels.

In 2020, we are seeing certain customers lengthen their payment schedules. And as a result, days sales outstanding increased by 10 days in the quarter, which corresponds to a $65 million increase to our accounts receivable investment versus the prior year period. Since we are experiencing improved payment patterns in recent weeks, we are modeling a modest sequential improvement to DSOs in the fourth quarter as reflected in our net working capital cash forecast.

Seasonal cash flows and our refinancing activities resulted in a mild sequential increase to our leverage ratio of 4.7x and net debt of approximately $2.2 billion. We are, however, maintaining adequate liquidity of approximately $434 million at the end of the quarter, which includes cash on hand of $284 million. We remain committed to our goal of reducing leverage and reaching a long-term target of approximately 3x net debt to trailing 12 months EBITDA.

On Slide 15, we compare our prior and current debt maturity schedules. You can see that we significantly extended maturities during the third quarter, and we have no material maturities until 2023. This provides the company with sufficient time to complete our DN Now transformation, generate higher adjusted EBITDA and convert a higher percentage of profits to free cash flow. We also will use the time to pursue continued operating margin and revenue growth opportunities with our digitally enabled solutions. Executing our plans will create a more favorable environment for potential ratings improvement and our ability to optimize our long-term capital structure.

On Slide 16 and as referenced in today's earnings release, we are tightening our 2020 outlook to the high end of our prior range, which we believe reflects the appropriate balance of opportunities as well as some risk for macroeconomic uncertainty.

We expect revenue will be approximately $3.85 billion, reflecting another sequential improvement in business activity. For adjusted EBITDA, we anticipate delivering approximately $440 million, inclusive of approximately $165 million of gross savings from our DN Now initiative. Our revised outlook for adjusted EBITDA falls within the company's original guidance range for 2020, which was communicated prior to the pandemic. And while we are confident in our ability to deliver a strong fourth quarter, we will be comparing against a very strong operating profit and EBITDA performance from the fourth quarter of 2019.

Free cash flow is expected to be around $30 million and includes the following approximate amounts: net interest payments of $150 million, restructuring and transformation payments of $110 million, $50 million of net working capital cash use, $40 million of cash taxes, $20 million of capital expenditures, $10 million of pension contributions and $30 million from balance sheet timing and other effects.

We firmly believe that our base operating model can generate a sustainable 50% conversion of adjusted EBITDA to free cash flow. To accomplish this long-term goal, we will need to eliminate restructuring transformation payments and have a more cost-effective and tax-efficient debt capital structure.

And now I will hand the call back to Gerrard for closing remarks.

Thank you, Jeff. I'd like to conclude our remarks today with a few comments about our focus areas as we exit 2020 and begin 2021. While we continue to operate in a highly dynamic environment, which is subject to ongoing change, it is our belief that in 2021, we will shift to a balanced agenda of higher free cash flow conversion and growth.

As it relates to free cash flow conversion, our DN Now cost program is expected to deliver around $160 million of savings in 2021 and with substantially lower restructuring spend than in 2019 or 2020. Higher free cash flow conversion will be underpinned by higher adjusted EBITDA, lower restructuring and improved working capital, partially offset by higher capital spend.

In parallel, we are pursuing several digitally enabled growth strategies: which include leveraging our DN Series recycled capability to improve our market position; building upon our momentum in retail self-checkout solutions; increasing our contract base with services, connecting those devices with the Allconnect Data Engine and upselling managed services; and expanding our market reach for cloud-native debit software. For each of these initiatives, we have defined a clear value proposition, which is resonating with a number of customers. We plan to build on our track record to low of success in the future.

While the economic landscape for 2021 is likely to remain uncertain and complex due to the COVID pandemic, we have demonstrated a track record of resilient operations, which provides confidence for our future. Going forward, our focus is on driving a balanced agenda of revenue growth, profit margin expansion and stronger free cash flow conversions.

With that, I'll hand the call back to our operator so that we may now begin with the Q&A session.

(Operator Instructions) Our first question comes from Matt Summerville with D.A. Davidson.

Maybe first, can you talk a little bit more on the ATM business, maybe by region? What you're seeing trend-wise? Success you've had with certifications. Any sort of metrics around the DN Series uptake? I guess I'm trying to get a feel as well for kind of where you're seeing greater relative strength and weakness in the ATM business.

Matt, pleased take your call. So overall, as we said in our prepared remarks, we saw solid order activity across all of our regions. If I double click into that in a little bit more detail, we saw a nice rebound in Asia Pacific. Within Europe, it's somewhat bifurcated, with some parts of Eastern Europe showing more strength relative to perhaps Southern Europe. We're seeing ongoing momentum in Middle East. And in the Americas, there's been broad-based activity, both in Northern and Southern Americas. So all in all, we haven't seen any material slowdown in order momentum from our customers.

As it relates to the DN Series, as I mentioned, we have seen 110 banks now complete certification. And as we move through the back end of 2020, we expect that number to climb quite a bit higher, which actually gives us a lot of confidence that we will hit the critical mass of shipments that we were expecting for DN Series in 2021.

As we think about DN Series and 2021, is there any sort of quantification you can put around in terms of how much of your current ATM bookings are related to DN Series? Maybe what percent of backlog is DN Series? And then ultimately, how much of your ATM volume would you expect to go out the door next year that is indeed DN Series? Any maybe initial view on that?

Yes. So Matt, those are very, very granular questions. So I'm going to maybe just pull it up a level. From a backlog perspective, it wouldn't be surprising for us to say that DN Series isn't yet the majority of our backlog just given that the backlog comprises selling activity through to all of 2020. What I will say is as we take look at orders that are getting booked right now, in most markets, DN Series is the dominant order that we're taking. And in certain markets, it's 100% of the orders that we're taking. And as we start to take a look at next year, some banks still have to work through their own certification processes. So I would say that we expect to be over the 50% threshold in terms of shipments that will come from DN Series next year.

Got it. And then maybe just one final one if I can see today. You mentioned several times in the prepared remarks the AllConnect Data Engine. Are there any kind of metrics you can talk about in terms of improvements you've seen in call or resolution, first time resolution rates? Any sort of improvements you've seen in uptime? Give a little bit more granular detail on the performance of that services model.

Yes. So the primary value-add from that model and a data analytics-driven approach, Matt, is it allows us to get much, much better in stake ahead of time as to what's going on in any given machine, which allows us to improve first time resolution rates, and in aggregate, reduce the number of calls per machine. What we're seeing gives us a lot of confidence to backstop the higher gross margin expectations that we've set for 2023 for ourselves. And more specifically on that point, we're seeing improvements that are, depending on the model, depending on the country, 20% to 30% reductions in call rates, which feeds nicely both in terms of the higher availability for customers as well as the improved productivity for us.

We will go to our next caller, and that is Justin Bergner with G. Research.

Nice quarter. And hope you, Gerrard, and Jeff are both well. Maybe just start off, in terms of -- there are a lot of moving parts this year between temporary cost-out. There were some strong software gross margins in the second quarter, which seemed to persist into the third quarter. So just sort of looking at the third quarter's results, maybe if you could just call out any unusually strong parts of the business, be it software gross margins or regionally. And any sort of lead parts of the business that might just sort of cloud how representative this quarter is to look at the profitability of the business going forward.

Yes. Justin, this is Jeff. I can answer that question. So there isn't anything unusual in the margin results for the third quarter. We had some of that in the second quarter when we called it out and talked about it. But what you're seeing in margins in the third quarter is the continuation of the improvement in services margin. And Gerrard talked about where we believe those services margins will end up. And then software, it's -- our software team is doing a tremendous job of managing professional service resource utilization. And you get some level of mix in there, but those are sustainable margins also. And then from product side, it's -- there is some effect to the level of product shipment.

But overall, I think we did extremely well. So we always are circumspect about projecting forward any margins. But generally speaking, there's nothing unusual in any of our margins that we need to call out this period.

Okay. And the mix effect in software, could you just sort of highlight that again in terms of what it is and why it may persist to some degree?

Yes, Justin. It's Gerrard. Let me lead off with that. Our software business has come under the same umbrella DN Now program as so many other parts of our business. And a big part of our emphasis this year has been on improving our professional services utilization and improving the mix of our delivery resources between global delivery centers versus more localized resources. Those are structural changes that we expect to perpetuate through to 2021. And in addition, this quarter, we also had some very strong software revenue activities from big U.S. banks in particular. So also benefited from some nice license activity in the quarter.

Okay. Great. That's helpful. And one or two more questions. I apologize that it may be redundant to some of your earlier comments. I hopped on a bit late. Just if maybe you could spell out sort of what are the enablers for the increase in the DN Now savings from -- I think it was last articulated at $130 million to the $165 million level.

Yes. Justin, yes, we announced previously that we had extended our relationship with Accenture relative to global business services areas and expansion in the other functions of the company. And that's going to take up our total savings through 2021 to $500 million. There is -- there are benefits that are going to extend beyond 2021, but we're focused on what we're going to deliver in 2021 as we make this -- 2021 is really the year that we're going to stop spending money on restructuring and transformation. We've drawn the line in the sand and said, look, we need to get through this so that we can focus the company on the future of the company, which is going to be about, obviously, continue to operate margin expansion, but more focused on growth and growing the top line.

So the $500 million is what we believe we will realize through the end of 2021. The increase is really associated with the expansion of our relationship with Accenture.

Got it. But just correct me if I'm wrong. Had you previously taken up the expected savings for 2020 all the way to $165 million? Or is there still some more pull forward?

There's -- $165 million is the 2020 number. That brings us to a total of about $340 million through the end of the year. It was $175 million and $90 million, $165 million in 2020. We did have incremental savings that we generated in -- especially in the second quarter during COVID-19 lockdowns that we don't count in that number. Those temporary savings such as reduced travel and expense will be a little bit of a headwind as we move into 2021, and we have to take consideration of that when we build our model and our plan for 2021. But no temporary benefits are included in our $500 million of DN Now.

Okay. Just maybe just to push a little further there. The $165 million of DN Now savings for this year mean that did seem to -- I mean, outside of the Accenture, I mean, the timing of that seems to be brought forward a little versus sort of maybe...

30 -- $35 million. Yes. Originally, we said $130 million. It's up to $165 million. We're just bringing in the benefits earlier than we originally predicted. And then we increased the total from $470 million to $500 million.

Okay. And then the temporary cost savings, were those still impactful in the third quarter or was it more de minimis?

Some of them are still happening in the third quarter, but we also had some headwinds sequentially in areas like G&A, especially in our long-term incentive comp one-off. I think that the headwinds in incentive comp at second quarter and the third quarter, because of the adjustments in the LTIP is over $15 million. And we did experience that some of those expenses came back, such as U.S. health insurance and so forth. And that was an unfavorable comparison sequentially, second quarter at $5 million.

So the costs are coming back. But we're still getting some level of benefit, especially on something like travel, where it's only essential travel at this point. But it's not a game changer relative to the overall operating results of the company.

Got it. And then maybe just lastly and one big picture question. How important is managed services to the P&L? Is it part of the confidence or -- in setting the longer-term service gross margin target of 32% to 33%? Or is its impact more through revenue, and how impactful can that be?

Yes. So Justin, at the moment, managed services is not a material driver. However, it is strategically highly relevant to our longer-term plans. We continue to believe that in a post-COVID world, more and more financial institutions will look to scale-based players like Diebold Nixdorf to outsource more of their ATM operations. And that certainly is an important element of how we think about growth going forward.

As it relates to how does that tie to the margin outlook, I'd say that the margin numbers that we shared are largely tied to the benefits we expect to see from our data analytics engine. If we were to see a meaningful shift in the portfolio much more towards managed services, we could see even more upward momentum on that front.

We will now go to Paul Chung with JPMorgan.

So just on your guidance, it looks like you are expecting a slightly less pronounced sequential bump in 4Q than you have in previous years. Is this a function of kind of customers waiting on the DN Series? Or do you expect less seasonality as we move forward?

And then secondly, on free cash flow, guidance implies pretty large harvesting of working cap in 4Q, but same thing on the DN Series. Kind of as we look out to fiscal year '21, should we expect more of the same? Or is DN Series kind of ramping in the first half? So maybe expect a little bit more uniform free cash flow throughout fiscal year '21.

Yes. Paul, why don't I take the first question and Jeff can take the second one? As it relates to Q4, we are expecting some level of seasonal bump. And I think you can see that when you back into Q4, take a look at our full year guidance. That being said, it is slightly lower than we would have seen in prior periods. And quite frankly, none of that has to do with DN Series. That has everything to do with this complex COVID environment we are seeing. I've talked in the past about solid order activity, solid momentum. And the reality is that's certainly true in some markets, but not all markets. Some markets are being more cautious. Some people are sitting on the sidelines. I think that, that's what you're seeing flow through our revenue view.

We do have a high degree of confidence in the seasonal trajectory for Q4 given that we're sitting at the end of October and our selling risk is negligible for the back end of this year. So obviously, as certain markets start to go into heightened states of lockdown, that would give one pause for concern. But as I said, most of our order activity for 2020 is now fully confirmed. So our revenue outlook for this year is solid.

Jeff, do you want to talk about the second question?

Yes. The working capital. Yes, we always, from a cyclical nature, have a harvesting of inventory in particular in the fourth quarter, our inventory. And this is why I said earlier that -- yes, we have cash usage for the first 3 quarters. And the biggest piece of that is the build of inventory for the fourth quarter -- product inventory for the fourth quarter. And we expect obviously, that for rather robust product sales in the fourth quarter, we're -- and just so you know, we're comping against a very good fourth quarter product sales from the prior year. So we expect to see that inventory investment come down significantly and be realized in cash.

The -- we're very focused on DSOs and receivables. That's high right now. It's higher than we've modeled. And as I said earlier, it's 10 days. We are modeling for a reduction through the end of the year. Not total. We won't get back to the same level of prior -- the prior year as we continue to work with our customers, but we expect to see improvement -- sequential improvement in DSOs in the fourth quarter. And we're already seeing that.

So yes, you're right. We're expecting to see a robust harvesting of working capital in the fourth quarter. As we unfortunately do every quarter, right, we'd like to level that out. We haven't done that yet. But you'll see a good cash flow in the fourth quarter that will bring us up to positive cash flow, and we provided forecast of $30 million.

And then on the DN Series kind of impact on free cash flow next year, maybe in the first half?

No, it's going to be minimal. It's -- as we move through that, the only place that we are really watchful relative to DN Series is in replacement parts. It won't be in finished goods. And our plants do a fabulous job relative to production planning. So it won't be a build in raw material. The place that we're very focused on the potential impact of DN Series is in spare parts, and we look at that weekly. And our service group does a tremendous job of managing through that. So we expect that, that's not going to have a significant effect on working capital investment as we move from legacy ATMs to DN Series.

We will move to our next question, and that is coming from Kartik Mehta with Northcoast Research.

Gerrard, I wanted to get your perspective on if you're seeing interest, whether it's in the U.S. or internationally, for branch automation machines. It seems like banks, at least in the U.S., are very focused on controlling their cost. And maybe COVID-19 gives them a reason to reduce the footprint or reduce people and automate some transactions. I'd be wondering, as you look at your backlog and maybe orders going forward, if that's part of the ATM orders.

Kartik, so if I just take a step back for a second. There's no doubt that there's growing conversations amongst banks, both in the U.S. and elsewhere around their long-term outlook for branches. And as part of that conversation, none of them are starting to rethink the cost of managing cash in aggregate. Now I'd say where we're seeing most of the heightened interest is in cash recycling technology, Kartik, as banks start to move small business deposits to ATMs and things of that nature. So it seems to be much more concentrated around cash recycling than purely around branch automation. And we're seeing that to be broadly universally true in most of the markets in which we operate.

And then, Jeff, obviously, a driver for the stock is free cash flow, and you've talked about free cash flow in 2020. And I know you're not in a position or don't want to give guidance for 2021. But can you just talk about some of the puts and takes for 2021 in terms of free cash flow? I know you've done a great job on net working capital, and maybe that is not going to be a benefit in 2021. I'm just trying to get a feel for the opportunity for you to really drive free cash flow in 2021.

Yes. I can take up the rest of our time talking about free cash flow in 2021, right? And thanks for the question. Yes. Well, let's just walk through it sequentially, and I'll tell you how we think about it. Obviously, we haven't given EBITDA guidance for 2021, but everybody's got their own model. So let's look at below EBITDA.

Restructuring, transformation payments are going to come down, right? And they're going to be -- we said $110 million for this year. They're going to be half of that, or we would like it to be less, but it's severance, and we're going to pay that severance as we move through some of these programs. So let's say it's half, let's say it's [$55] (corrected by company after the call) million. So you pick up, we're going to pick up cash there. Working capital, we are spending money this year because of COVID-19 effectively. We think that's going to go back to normal and we get back to the end of '19 levels. So we should get a little bit of benefit from that going forward. By the way, long term, then post '21, transformation, restructuring is 0, right? And then we expect working capital to be more neutral going forward.

And from a tax perspective, we're going to -- we continue to work on cash taxes. We'll get that down. But eventually, the bad thing about becoming a more profitable business is, eventually, we're going to have to pay taxes, and it will be about -- around 30% effective tax rate. And then CapEx is going to be up in '21 because of some of the digital -- internal digital things we have. So we haven't given guidance on the total, but it will be up materially from what we'll experience in 2020. And obviously, EBITDA is going to be up, so it will contribute.

So I'm not going to give guidance today. But it's going to be better than $30 million. It will be back to what we thought we were going to get per our original plan for 2020 or a little higher than that based on EBITDA growth.

Gerrard, just one last question. As you look at the retail and banking sectors, during the height of the COVID-19 pandemic, did you have order cancellations or just order delays? And are either of those now turning? Are the order delays now being installed? And if there were order cancellations, are those the ones that are coming back?

Yes, Kartik, we have not had any order cancellations at all. So we saw order activity shrink in Q2, as we talked about, and we saw a bunch of that come back. Some of that has really been a combination of orders that were being delayed that are now playing catch up, plus the normal pattern. So we are seeing a combination of delays coming through as well as normalized activity.

We will take our final question from Jeff Harlib with Barclays.

So for 2021 outlook for revenue improvement, can you just talk generally about how much of that is some expectation from reduced COVID delays, how much from DN Series ramping, and also on the retail side, where you've obviously seen some improvement in self-checkout momentum?

Yes. I think it's probably premature on our part, Jeff, to start to delineate the actual sources of growth right now. But at a high level, let me tell you how we're thinking about it. Within the retail business, we've talked about the momentum that the industry is seeing in favor of self-checkout, and we think that, that will be a material driver of retail activity and incremental growth for 2021. And don't forget that our retail business skews materially towards large multinational retailers. And we're seeing positive buying intentions from a large group of them.

As we move on to the banking side, I think we're anticipating strong activity from DN Series, in particular, around our recycling business. As you take a look at the momentum we're hearing from multiple markets, we think we will continue to be a rebound in product activity as well as ongoing strong interest in our software assets and our services business.

Obviously, the unknown question out there is just how badly will COVID impact 2021. And at this stage, what we've been looking at is the way in which the business has recovered through Q3 and the level of buying activity we're seeing unfolding in the early part of Q4. And if those patterns broadly continue through 2021, the outlook that we have for -- that we've shared will hold true. Obviously, if there's any other material lockdowns that have the world look more like Q2, we're willing to revisit that. But we've shown a high degree of resiliency working through this pandemic. So I'd say from where we sit today, our view around 2021 at this stage is pretty optimistic.

Okay. Okay. And then on the $160 million of savings expected for 2021, can you just talk generally about areas of reinvestments that you see, whether it's R&D, new product, incentive comp, et cetera?

Yes. This is Jeff. We continue to spend on R&D. I mean you can look at our P&L, as you can see that we haven't cut R&D spend. We continue to invest in systems and process and managed services and product. So I don't see any increase in that unless it's specific to a product that we're developing. And maybe we should give a little more color to that going forward, especially when we start talking about growth in the coming quarters.

From a capital perspective, look, we will spend money on internal systems, in our -- on our own digital -- internal digital capabilities in '21 and '22. But overall, this is not a heavy capital commitment business. We maintain adequate -- other than R&D, we maintain our plants, and when we need to, we invest in them. And when we invest in anything greater than our normalized maintenance and customer support capital, we'll let you know. But there's nothing on the horizon right now other than R&D, continued R&D spend.

I don't know, Gerrard, do you have anything to add?

Yes. Let me build on that, Jeff. There seems to be, at least in the minds of some, a perception that we've been starving the business from growth. And that's quite frankly, just not factual at all. As Jeff said, our R&D levels have been at historical and heightened levels as we've continued to enhance DN Series, as we've continued to launch our digital offerings in our software business and around AllConnect Data Engine. And all of our cost savings have been geared around our internal operating efficiencies.

So while CapEx on buildings and nonrevenue-generating activities have come down, we've been very, very clear to protect our investments that will fuel future growth. And that's part of what you're seeing coming through now as we start to think about how we're positioned for 2021 across DN Series, across self-checkout and across our digital assets.

Okay. Just lastly, a quick follow-up. On the nonrecurring temporary cost savings, I think previously, they were expected to be about $50 million for this year. It sounds like that will be much lower. And will there be -- are there any benefit then from the sort of temporary cost actions?

No. We have benefit this year. Just -- let's just frame it correctly. We will carry $160 million of DN Now savings into 2021 to get to the $500 million. There will be some benefits from -- that we experienced in 2020, for example, deferred merit increases. As I said earlier, U.S. hospitalization spend during the lockdown was lower for everybody. T&E is lower for everybody. Those things will come back over time, those expenses, and we have to account for them as we roll forward our model into our 2021 plan.

So there will be a $160 million of benefit. There's going to be some offsetting effect from those savings, those temporary savings from 2021. Let's say, it's $50 million to $60 million that will roll into '21 that we'll have to take into consideration, almost like inflation coming through in the model for '21. But the net effect is the cost savings before we get the revenue growth will be positive.

That concludes today's question-and-answer session. Speakers, at this time, I will turn the conference to you for any closing remarks.

Our colleague in IR seems to have an audio issue. So let me take this as an opportunity to thank everyone for joining our Q3 earnings call, and we look forward to hosting you for our next call. Thank you, everyone.

Thank you, and thank you all for your attention. This concludes today's conference. You may now disconnect.