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Diebold Nixdorf (NYSE:DBD)
Q1 2020 Earnings Call
May 05, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

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

Steve Virostek -- Vice President of Investor Relations

Thank you, Serge, and welcome, everyone, to Diebold Nixdorf's first-quarter earnings call for 2020. Joining me today are Gerrard Schmid, president and chief executive officer; and Jeff Rutherford, chief financial officer. For the benefit of our participants, we have posted slides, which accompany our discussion. And these slides are available on the Investor Relations page of dieboldnixdorf.com.

Also, we will post a replay of our webcast to the IR website later this afternoon. 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, 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that our forward-looking information is current as of today, and subsequent events may render this information to be outdated. And now I will pass the microphone to Gerrard.

Gerrard Schmid -- President and Chief Executive Officer

Good morning, and thank you to everyone for joining earnings call. Due to the widespread and global implications of the COVID-19 pandemic, I will spend most of my prepared remarks discussing our response plans, the resiliency of our model and customer validation of our value proposition. We were very pleased with our results this quarter, and Jeff will get into details. From our perspective, we are executing in line with our strategy.

We delivered stronger-than-expected orders, especially in Eurasia Banking and retail. While revenue was in line with our pre-COVID expectations, and we continue to deliver strong year-over-year improvements in profitability. Starting on Slide 3, I'll describe our near-term priorities. From the earlier stages of the crisis in January, our first priority has been on protecting the health and well-being of our employees.

Our second priority is on our mission to deliver essential services as designated by the U.S. government and many other governments around the world. Almost 100% of our banking revenue and around 65% of our retail revenue is generated from customers that are essential businesses. I'm extremely pleased that we have consistently delivered strong service levels: banks, grocery stores, pharmacies and fuel and convenience locations, which facilitate critical day-to-day commerce.

Thirdly, we are committed to strengthening Diebold Nixdorf during this crisis. This means leveraging the operational rigor we have forged over the past two years to drive efficiencies in our business. It also means we are taking further steps to maintain adequate liquidity and ensure financial flexibility. Our response to pandemic is guided by our company values, shown on the right side of the slide, which have been in place and have underpinned our progress over the past two years.

Starting with collaboration. Our employees are using technology to collaborate on an unprecedented scale to meet customer needs and address business challenges. This is taking place despite the social distancing protocols we operate under. We're acting with a great sense of urgency and decisiveness as we seek to enhance the way we do business, for the betterment of customers and shareholders.

And more than ever, our team is stepping up to hold one another accountable. On Slide 4, I'd like to add more color to our comprehensive response plans. Starting with our customers and solutions. We are delivering strong service levels, which reinforce our value proposition, even in the hardest-hit areas of the world.

In turn, our customers have affirmed our value and the criticality of the ATM and retail checkout channels. Two recent customer quotes on this slide, one from a European grocer and the other from a large financial institution in the U.S., up to the essence of our value proposition. And we continue to enhance our differentiation by bringing to market our DN Series next-generation banking solutions, self-checkout solutions, dynamic software and our IoT-enabled AllConnect Data Engine. Turning to our employees.

We've gone to great lengths since early January to proactively care for their health and well-being. We have equipped our service technicians with the appropriate protective gear and trained them on relevant hygiene and social distancing rules. For employees and our manufacturing facilities, we have segmented our workers, intensified our cleaning rituals and are taking temperatures on a daily basis. And for our support functions, we have provided the proper tools, resources and guidance for more than 10,000 employees to safely and productively work from home.

I'm pleased to report that our efforts are making a difference, and we are operating well in all areas of our business with no disruptions despite these circumstances. We're also looking out for the financial health of employees as well during this tumultuous time, by establishing an employee crisis reserve fund, which is available for employees who need support, especially in markets with limited government programs. In recognition of the tremendous efforts of our frontline service employees during this challenging time, we have provided an extra week of pay. Additionally, our company has increased the frequency and depth of its internal communications.

In return, we're seeing strong employee engagement and resourcefulness during this crisis. In addition, I'm pleased to see Diebold Nixdorf actively supporting our communities. In Ohio, we've been producing face shields and shipping them to medical facilities in need. In Germany, we started manufacturing ventilated carriages.

Our manufacturing facilities are all online and performing well. With respect to our global supply chains, members of our response team have been vigorously engaged since January to avoid major disruptions by maintaining frequent contact with our key suppliers, monitoring safety stocks and developing contingency plans. While COVID-19 is likely to remain as a watch item for supply chains over the coming quarters, we are currently pleased with our ability to limit the impact. Our comprehensive response is leveraging the operating rigor, which we've created during the past two years.

We continue to efficiently manage inventory, receivables and payables, as well as indirect spend. And we are keenly focused on maintaining adequate liquidity and financial flexibility. After an abundance of caution, we drew the remaining amount on our revolving credit facility in March. On Slide 5, we provided a framework for thinking about the impact of COVID-19 on Diebold Nixdorf over the medium term.

Firstly, our business model is resilient. Underpinned by many customers, reaffirming that the ATM and self-checkout channels are vital to their business, and that our company plays a critical role in their ability to serve the needs of their customers. Starting with our services business, which generated about 51% of total revenue in 2019, we expect a mild impact as the vast majority of our services revenues are recurring. It comes from sticky contracts for maintaining critical ATMs and retail devices.

In the near term, we're likely to see a slowdown for installation service revenue. Certain hardware-related projects are pushed out. For our products business, which accounted for about 39% of revenue in 2019, we expect to see a moderate impact of certain customers postpone installation dates or defer new hardware purchases. In the first quarter, we experienced early signs within our European retail and Eurasia Banking segments, which corresponds to the geographic spread of the virus.

And while we did not see an acceleration of these trends in April, it is reasonable to expect that product revenue declines will be more pronounced in the second quarter. We've taken multiple steps within our manufacturing operations to create a variable cost structure to help us mitigate the impact of lower volume on our profitability. Moving to our software business. We generate recurring revenue from the sale of licenses and maintenance, which we expect will be very resilient.

Our project-based business, or professional services, could be affected by customers deferring initiatives, although we have experienced very limited impact to date. The vast majority of our customers are continuing this important work. Additionally, our software teams have done a great job of supporting customers remotely. For these reasons, we expect a mild impact to our software revenue, which accounted for about 11% of total company revenue in 2019.

From an industry perspective, we expect our banking business, which generated approximately 74% of the company's revenue during 2019, will show greater resiliency in our retail business, due to the higher mix of services and software revenues. So while we are confident in the resilience of our business model, we've not been standing still during this time. We continue to take further decisive actions to strengthen Diebold Nixdorf. On Slide 6, you will see that we continue to execute on our multiyear DN Now cost program.

We remain encouraged with our achievements, including substantial gains in profit margins during the first quarter. We are seeing good progress from our services modernization plans and our G&A cost reduction actions, especially our finance transformation efforts. And while COVID-19 pandemic has mildly influenced select work streams, we are continuing to pursue our gross savings target of $130 million for the year. Additionally, the company launched incremental actions during the quarter, which cumulatively add up to another $80 million to $100 million of savings.

We have suspended capital investments on internal major projects, mostly related to the upgrading of systems. During the quarter, we also reduced our annual bonus expense by a substantial amount. We have deferred merit pay increases and have implemented a hiring freeze. In several European markets, we have transitioned certain functions to shorter work weeks.

We continue to reduce indirect spend. And based on our successful transition to remote work environment, we have reassessed our global real estate footprint and are taking decisive actions to further reduce our footprint over the coming months. While some of these cost reductions will be temporary, others will generate long-term structural savings for our company. Now I'll turn the call over to Jeff to provide details on our first-quarter results.

Jeff Rutherford -- Chief Financial Officer

Thank you, Gerrard, and good morning, everyone. During my prepared remarks, my comments will focus on non-GAAP metrics, unless otherwise noted. Beginning on Slide 7. First-quarter revenue of $911 million was in line with our pre COVID 19 expectation and reflects the actions we are taking to drive higher quality revenue.

In order to make useful comparisons to the prior year, we have provided a table to explain five different factors. Our work stream for divesting noncore businesses accounted for approximately $13 million of revenue variance versus the first quarter of 2019. Next, you can see a $17 million variance from our efforts to reduce our exposure to low-margin business with most of the impact relating to our actions to call our portfolio of lower value services contracts. On the borrowing line, you will see a $31 million variance, which includes nonrecurring volume from the prior year period, partially offset by incremental activity in the current quarter.

These items were fully known and planned for as part of our 2020 operating plan. We have previously communicated our expectation for year-over-year revenue declines in the first half followed by gains in the second half of the year. With respect to foreign currency, we experienced headwinds of $23 million in the quarter as the U.S. dollar strengthened primarily against the euro and Brazilian real.

COVID-19 is the last factor on this table. Approximately $33 million of revenue, which we expected to recognize in the first quarter of 2020, will be recognized in future periods. This effect was predominantly in our retail and Eurasia Banking segments. Transitioning to the right of this slide, you will see the combined efforts of higher-quality revenue and our DN Now initiatives, as non-GAAP gross profit increased $7 million year over year.

We achieved this positive result despite the effects of COVID-19 and a foreign currency headwind of approximately $7 million in the quarter. From a gross margin perspective, we are pleased to deliver a 380-basis-point increase year over year to 27.9%. On $911 million of revenue, this increase translates to approximately $35 million of incremental gross profit. We are delivering significant margin increase across all three business lines, with services rising by 230 basis points, products expanding 280 basis points, and our software and gross margin increased by 1,280 basis points due to an easier comp, as well as better delivery and management of our labor costs.

Over to Slide 8. As previously mentioned, the company is harvesting operating efficiencies and from functional G&A cost as part of our DN Now transformation. We made good progress on our finance transformation, which includes regionalizing and centralizing activities, and introducing automation within our core finance functions. Through the end of March, we have streamlined our organization by approximately 470 employees.

Our procurement initiative is also bearing results as we are utilizing spend analytics to reduce indirect spend. With respect to real estate expenses, we are looking closely at our needs post COVID. We have demonstrated a highly resilient ability to work remotely. And accordingly, we are aggressively moving to reduce our real estate footprint.

In the past several weeks, we have decided to close greater than 50 smaller sites permanently. When compared with the prior year, we reduced our non-GAAP operating expenses by $29 million, a decline of 13%. Given this success, we expect to continue to deliver G&A efficiencies going forward. As displayed on Slide 9, stronger gross margin, coupled with reductions to operating expense, boosted our operating profit by $36 million or 133% year over year to $63 million.

The operating margin expanded by 430 basis points in the quarter to 6.9%. Our first-quarter results include a reduction to our annual bonus expense of approximately $7 million, which is just one of our incremental actions we have executed to strengthen the company during the COVID-19 period. Adjusted EBITDA of $89 million improved by $24 million or 37% over the prior-year period. The company's adjusted EBITDA margin expanded by 350 basis points in the quarter to 9.8%.

The next three slides provide segment-level financial information. In order to make the year-on-year comparisons more meaningful, we introduced adjusted revenue and gross profit for the first quarter of 2019, which removes the effects of foreign currency and divestitures. We are showing gross profit on these slides to more closely reflect how we are running the business. However, we will continue to disclose segment operating profit in the MD&A section of our Form 10-Q.

As Gerrard mentioned earlier, Eurasia Banking delivered very strong orders in the first quarter and built up a nice backlog. These wins included a new ATM-as-a-Service contract with Bank99 in Austria, valued at more than $20 million in a branch transformation win, valued at more than $13 million with a large Saudi Arabian financial institution. Moving to Slide 10. First-quarter revenue of $311 million was in line with our pre-COVID expectations.

Approximately $13 million of the revenue decline was due to our divestiture activity, while $8 million was due to our delivered actions taken in 2019 to reduce low-margin business. Additionally, certain large hardware installations benefited 2019 revenue, which did not continue in 2020. Delays from the COVID-19 pandemic pushed approximately $14 million of revenue into future periods. Non-GAAP gross profit of $90 million in the quarter and a gross margin of 28.9% reflects the resiliency of this segment as we benefit from our DN Now services modernization and software excellence initiatives, as well as our intentional actions to reduce low-margin business.

First-quarter gross profit includes a foreign currency headwind of approximately $4 million versus the prior-year period. On Slide 11, Americas Banking revenue of $345 million reflects a 3% decline, primarily due to our constant decision to exit lower margin service contracts. Within our products revenue, we are seeing good growth from U.S. regional financial institutions, although nonrecurring projects at large banks in North America eased year over year as we had expected.

During the quarter, we were especially pleased to generate software revenue growth of 13% in constant currency. Gross profit of $104 million for the quarter increased 30% versus the prior year due to the execution of our DN Now initiatives and a favorable customer mix. We were pleased to expand gross margins from 22.7% to 30.3%, with meaningful contributions from all three business lines. Key to our success was services gross margin of 32.1% for this segment, reflecting very good performance from our services modernization initiative.

Slide 12 contains financial highlights for our retail segment. From an orders perspective, retail performed as we expected and was in line with the prior-year period. Revenue of $256 million primarily reflects lower POS installation activity in Europe, partially offset by growth in self-checkout hardware and higher software activity. Both results came in as expected.

The impact of the pandemic was more acute in this segment, pushing approximately $19 million of revenue out of the quarter. Gross profit increased to $60 million, up 11% in the quarter, and gross margin improved significantly to 23.4% due to a favorable revenue mix from services software and self-checkout solutions, as well as solid progress with our services modernization and software excellence program. Our cash flow update is on Slide 13. As we discussed previously, the company has been consistent and are disciplined in managing our net working capital over the past several quarters.

Net working capital as a percentage of trailing 12-month revenue declined steadily over the last seven quarters, down to 13.3% in the first quarter of 2020, down from 19.1% a year ago, due primarily to more efficient management of inventory and accounts payable. From a cash flow perspective, net working capital drove a $15 million benefit year over year. Because of our focus, we believe the company is well prepared to manage net working capital during the current challenging economic conditions. As communicated previously, the company typically uses cash during the first half of the year and our free cash use of $65 million in the quarter was slightly better than our expectations and slightly improved versus one year ago.

First-quarter results include an incremental $35 million of compensation-related cash payments tied to our strong 2019 performance. Adjusting for this item, you can clearly see that we are delivering high-quality earnings in addition to our net working capital efficiencies. Towards the bottom of the slide, we bridge our cash balances from the end of 2019 through the end of March. We used approximately $71 million to pay down debt.

This includes our amortization payments, as well as our contractual requirement to reduce debt with at least half of our free cash flow from the prior year. Since I have already discussed our free cash flow, the next item is cash inflow from our revolving credit facility. We drew the entire available amount from our facility in March out of an abundance of caution in light of the evolving COVID-19 pandemic and related macroeconomic implications. This action has almost no impact on our expected cash interest payments of approximately $170 million because the incremental interest on the revolver will largely be offset by lower LIBOR rates for other debt instruments.

An additional $89 million reduction of cash is attributed to foreign currency headwinds experienced in the quarter, plus the effect of selling our 68% stake in the German IT outsourcing business called, Portavis and one other pending transaction. With a cash balance of $549 million at the end of March, we believe we have adequate liquidity to fund the seasonal cash flows of our business and our DN Now transformation program. On Slide 14, we highlight our debt maturities and leverage ratio. Our contractual debt maturities of $98 million for 2020 and $26 million for 2021 are manageable under our current liquidity model.

We continue to monitor the debt markets relative to our strategy to address our 2022 debt maturities. At the appropriate time, we will take steps to optimize our capital structure by reducing our weighted average cost of capital, lowering interest rates and extending maturities. To the right of the slide, we have provided our net debt to trailing 12 months adjusted EBITDA ratio for the past five quarters. As you can see, we have steadily improved this metric and we are pleased to maintain the 4.4 times ratio in the first quarter as our adjusted EBITDA gains offset the changes to net debt.

This compares favorably to our bank covenant maximum of 7 times. Our net debt on 31st March was approximately $1.9 billion. Moving to Slide 15. I will build upon Gerrard's comments about the financial resiliency of our business model and provide a few guideposts for understanding how we expect to perform under challenging macroeconomic conditions.

For your convenience, we have provided selected financial results from 2019, including revenue and gross margin for services, products and software. We expect our services business to be resilient during this time, with a mild impact to revenue. As previously disclosed, we expect to complete two divestitures in 2020, which generated about $110 million of services revenue for the company in 2019. One of these transactions closed in Q1, with the other expected to close in Q2, subject to customary closing conditions.

Additionally, the software we deliver for our customers is critical to their performance, and therefore, we expect a mild impact for COVID-19 to this business line. With respect to product revenue, we expect a moderate impact based on what we have seen thus far, as well as the company's experience from prior recessions. Given the timing of the crisis, it is reasonable to expect a more significant impact of product revenue in the second quarter as certain product installations are expected to be delayed during country lockdowns while other hardware orders are postponed. Our current cost structure and incremental action plans provide us with the confidence to improve gross margins during this challenging time.

We are targeting improvements to service margins due to our actions to improve the quality of revenue and execution of the services modernization plan. For products, we expect to deliver broadly stable gross margin due to our variable cost structure and our solid performance in the first quarter, inclusive of some level of higher freight costs. At the same time, we expect to improve our software margins versus the prior year due to better project execution and more efficient utilization of labor. Moving to operating profit.

We expect to benefit from our DN Now initiatives and our plans for realizing approximately $130 million of savings for 2020. And while COVID-19 is having a mild influence on select DN Now work streams, we have also launched incremental actions to generate $80 million to $100 million of savings, as Gerrard described. These actions include: accelerating our finance transformation, streamlining indirect spend, significantly lower bonus expense and other labor savings, reduced travel and marketing expenditures and savings from our real estate and information technology initiatives. Together with our net working capital efficiencies and cash management actions, we are targeting breakeven free cash flow for 2020.

By minimizing the uses of cash, we will maintain adequate liquidity and covenant compliance through 2020. In summary, this leadership team has taken significant and appropriate action to strengthen the company during these challenging times. Our accomplishment, near-term plans and company values provide us with the confidence to persevere. We are hard at work executing these plans, and we are developing additional levers to be used as needed.

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

Gerrard Schmid -- President and Chief Executive Officer

Thanks, Jeff. I'd like to conclude on Slide 16 with a few reminders about why we believe Diebold Nixdorf is well-positioned to persevere through this crisis and emerge as a stronger company. I'll also provide a few color comments regarding April. First, we've been designated as an essential service provider to financial institutions and retailers.

Our customers are counting on us to keep their businesses running. And during this crisis, the criticality of the ATM channel, point-of-sale and self-checkout channels have been reaffirmed strongly. Next, our position as a trusted technology partner produces strong recurring revenue streams, which underpins a resilient business model. Furthermore, our leadership team has demonstrated resiliency and an ability to execute complex transformation initiatives over the past two years.

Considering DN's operational rigor and our incremental cost actions in place, we are confident in our ability to navigate the current environment and emerge as a strong company. Before we turn over to Q&A, let me offer a few thoughts on what we saw in April. From an order entry perspective, we are seeing a moderate slowing in hardware decisions from customers in Eurasia Banking and retail, where projects are being delayed and not canceled. Within Eurasia banking, these delays tend to be mostly evident within smaller Tier 2 banks.

Within Americas Banking, order activity has remained largely in line with our pre-COVID expectations. Regarding installations, we have seen some hardware installations push out, typically by several weeks as customers focus on other priorities. In April, our factories shipped more volume than in the same period of 2019, reflecting the backlog as we entered Q2, even though we may see some implementations pushed out of Q2. From a services perspective, we continue to be fully engaged with customers in delivering strong service levels.

And from a software perspective, we've not seen any delays in professional services projects from larger customers, but the only delays observed among Tier 2 and Tier 3 customers. Overall, employee morale remains strong as we rally around our customers' needs and implement incremental actions to strengthen Diebold Nixdorf. In closing, while the current operating environment is dynamic, we remain confident in our people, our mission and in the resiliency of our business. We stand ready to support our customers as the global economic economy recovers.

Our confidence is based on the DN Now foundation we've built over the last two years, the robust plans we're executing and the tremendous response we're seeing from Diebold Nixdorf employees who are living out at company values. With that, I'll now turn it back to the operator, Serge, to support our Q&A.

Questions & Answers:


Operator

[Operator instructions] Your first question comes from Matt Summerville of D.A. Davidson. Please go ahead.

Matt Summerville -- D.A. Davidson -- Analyst

Thanks. A couple of questions. First, Gerrard, can you maybe talk about how COVID-19 may be impacting the timing of the commercial availability of the DN Series? And if there's any sort of difference between the regions? If you could provide color around that as well?

Gerrard Schmid -- President and Chief Executive Officer

Yeah. Good morning, Matt. Thanks for the question. So I think there's two parts to the question.

COVID-19 is having no impact on our R&D or engineering capabilities to ensure that the full range of DN Series is available for the market. I'd say that where we are seeing some impact is not as notably in Eurasia unsurprising. We're seeing a little bit of a slowdown of customers undertaking their certification processes, primarily due to the fact that they can't access their own customer labs as they work remotely. So we've not seen any change in customer appetite, more somewhat of a modest delay in the execution of the certification series due to their inability to access their labs.

Matt Summerville -- D.A. Davidson -- Analyst

And then with respect to the incremental $80 million to $100 million of cost-out actions you guys are discussing this morning, should we assume that that's a pretty one-for-one sort of drop-through rate down to operating profit? And then how much of the $80 million to $100 million is more structural in nature? Thank you.

Jeff Rutherford -- Chief Financial Officer

Yeah, Matt, this is Jeff. A large percentage of those savings are going to be one-time. We talked about the reduction in bonus. We talked about the deferral of merit increase we have some other actions we're taking that have been made available to us government programs, subsidy programs, and we also are participating in the government bat and payroll and income tax deferral programs.

So all those things make up a majority of that $80 million to $100 million. But there are also some permanent items in there related to acceleration of finance transformation, what we talked about relative to real estate, some other areas of functional cost reductions that we didn't get in any detail about. So it's a mixed bag, but a large portion of that is going to be one-time.

Matt Summerville -- D.A. Davidson -- Analyst

Got it. Thank you, guys.

Operator

We will now move to our next question from Paul Coster from J.P. Morgan. Please go ahead.

Paul Coster -- J.P. Morgan -- Analyst

Yeah. Thanks, Gerrard. My question is really slightly long term. And I'm sure you can anticipate this, but it feels like the world's changed, that contactless retail behavior may be involved moving forward.

Are you seeing any evidence of a change in behavior? Maybe there's two ways to address it. One is in terms of the mode with which people will be behaving in retail and banking and the volume of activity moving forward, whether you see any change to your long-term prospects from any changes induced by COVID?

Gerrard Schmid -- President and Chief Executive Officer

Good morning, Paul, and thanks for your question. So let me start by saying that there's been a long-standing debate around the relevancy of the ATM channel. And there's no doubt that COVID-19 has reaffirmed in spades the strategic relevancy and criticality of the ATM channel as banks contemplate their long-term needs. So I'd say if anything, we see that as a structural reaffirmation of the strategic relevancy of the channel.

So I'll make some comments on banking, and then I'll shift toward retail. As we think about what does that mean due to changing consumer behaviors, and we're starting to see growing interest from our customers for more tactical antimicrobial coatings on the ATMs. We're also seeing, obviously, unsurprisingly, heightened interest in pre staging of cash withdrawals from mobile phones. But I'd say that as banks contemplate the long-term relevancy of bank branches.

We're seeing emerging interest, but it's still early days for banks to think about more sophisticated kiosks where they can use those to embed more IP rather than depending on a manned bank branch. So I think those are some of the factors that are on our mind as we look at banking going forward. I think that from a volume perspective within banking, during the steepest part of the lockdown phases, we certainly saw a material drop in cash withdrawals, unsurprisingly as people stayed at home. As markets have started to open up, we've seen the vast majority of those volumes rebound.

Although clearly, one of the questions out there is whether there will be a slight dampening longer term effect? From a retail perspective, there's no doubt that interest in self-checkout continues to grow. That was certainly a strong conversation set for us pre-COVID in Europe and post-COVID. As markets are opening up, we're seeing that level of interest continue to heighten as retail shift toward more unmanned checkout devices. And certainly, there certainly seems to be some growing interest in touchless versions of self-checkout.

But I would say, more broadly, from a volume perspective, we're not doing our retailers anticipate depressed volumes. And when I say those comments, they're primarily viewed around our essential retailers like grocery stores, which make up the majority of our retail business. I think that the other thing that I expect to see across both retail and banking is heightened interest in managed services. As banks and retailers think about their total cost structure going forward, we believe that we will see heightened interest in broader outsourcing opportunities and some of the wins that Jeff talked about or evidence of that growing interest.

Paul Coster -- J.P. Morgan -- Analyst

Well, thank you. Got it. One quick follow-up, perhaps for Jeff. And that is, do you see any credit exposure, any risk and not so much in the accounts receivables, but perhaps in your backlog and pipeline?

Jeff Rutherford -- Chief Financial Officer

No, we're not seeing anything right now. But I can assure you we spend a lot of time looking for it. And what we're running is -- one of the advantages of where people mix or and the experiences we had in 2018 and 2019 as we are very acutely engaged in working capital management, we run some very detailed direct cash flow models. And we are now meeting on a weekly basis with Gerrard and the finance team, and we are reviewing DSOs and DPOs and DIOs in a very detailed manner.

And we are very acutely aware of what's going on relative to working capital and cash flow. But to answer your specific question, we have not seen anything yet of any material nature.

Paul Coster -- J.P. Morgan -- Analyst

OK. Thank you.

Operator

We will now move to our next question from [Inaudible] of [Inaudible]. Please go ahead.

Unknown speaker

Thank you very much for this useful presentation. I have a couple of questions. So first one is how much of the Q1 '20 revenue was nonrecurring in nature?

Gerrard Schmid -- President and Chief Executive Officer

When you say -- the first-quarter revenue nonrecurring, you mean relative to just a more short-term purchase order?

Unknown speaker

Yeah, exactly, yeah. So it's kind of -- I'm trying to basically think about -- so I was going to say, I'm trying to think about when you described, Q1 '19 had a decline of $31 million due to nonrecurring revenues. I was just thinking in the same way, is there any nonrecurring on short-term Q1 '20?

Jeff Rutherford -- Chief Financial Officer

Yeah. So just remember what our revenue, and it lines up with the resiliency discussion Gerrard had is that our services revenue is generally longer-term contract oriented. So that is a longer-term resilient revenue base. And the same is true of software.

That's why those two areas are deemed to be more resilient. Hardware tends to be based on purchase orders and refreshment needs of either retail or banking customers. So they're nonrecurring. So it's based on the individual retailer or banking customers, refresh cycles, so what happens is if we have very large refresh cycles like we had in the first quarter of '19 that do not recur, right, we'll get an effect like we had in the first quarter relative to nonrecurring refresh.

Now what we have is -- and based on Matt's earlier question, we have the DN Series coming out in the back half of this year or was planned to come out in the back half of this year. So we're going to see some shift, as we talked about earlier from the first quarter -- under normal times from the first quarter to the second half in large refresh cycles. Gerrard, anything to add on that?

Gerrard Schmid -- President and Chief Executive Officer

Yeah. I could just add a couple of comments. If you think back to the comments we've made in prior quarters, one of the key themes we observed in 2019 was very, very strong order activity coming out of the Americas due to Windows 10 upgrade activities, with first part of 2019 being particularly strong with larger banks. And we've been quite clear and we've been expecting a slowdown in those activities as we enter 2020.

So when you take a look at what was unfolding in Q1 of 2020, there were very few big one-time events unfolding, and there's a spread more uniformly over our customer base. So I don't think we'll see as much of a concentration in Q1 of 2020 versus the same period last year.

Unknown speaker

OK. That makes sense, yeah. And then my second question is in terms of the services division and servicing ATMs, if we see maybe a slightly reduced usage, if people are kind of staying at home and not really going out to ATMs or bank branches, do you foresee a reduced need from your customers to have servicing? Are your contracts based on -- can you remind me if your contracts are based on a number of levels of service in terms of frequency? Or they're just general servicing agreement that covers their footprint?

Gerrard Schmid -- President and Chief Executive Officer

The vast majority of our services contracts are related to the units being serviced, not the underlying transactional activity. Yes, so clearly, during the steep lockdown periods, we saw a moderation in transaction activity in some markets. But in other markets, we saw an increase in transactional activity. So our contracts don't expose us to their variability as they're tied to two units.

Unknown speaker

Great. Thank you.

Operator

We will now take our next question from Ishfaque Faruk from Sidoti & Company. Please go ahead.

Ishfaque Faruk -- Sidoti and Company -- Analyst

Good morning, Gerrard and Jeff. Firstly, on the DN Now initiatives, it seems like you guys are stepping up your cost-cutting on the DN Now initiatives. Is that what you're seeing is like leading to the step-up in the gross margin?

Gerrard Schmid -- President and Chief Executive Officer

Ishfaque, the primary driver of our gross margin improvement certainly has been the sustained execution of our DN Now program, primarily across our services improvement plan, plus the emergence of momentum out of our software excellence program. Those are the two big good drivers within our gross margins. And then obviously, the second equally important part of our DN Now initiative has been the reduction in our G&A cost base, primarily led by Jeff's efforts in the finance transformation program.

Ishfaque Faruk -- Sidoti and Company -- Analyst

Got it. And in terms of certification -- I'm sorry, I joined the call a few minutes late. Did you mention how many banks are certifying now?

Gerrard Schmid -- President and Chief Executive Officer

There's been an increase in the number of certifications under way relative to our last reporting period. I don't have those numbers off the top of my head right now, but we can certainly share those at a subsequent period. But what I had said, Ishfaque, is that in some markets, especially those that went through more pronounced lockdowns. We have seen a slight elongation of the certification process, and banks have been unable to get to their own customer labs.

There's been no degradation whatsoever in terms of customer interest in the DN Series, but a slight elongation of the certification process.

Ishfaque Faruk -- Sidoti and Company -- Analyst

Got it. And when it comes to shipments of banking products, as well as retail products, do you expect like most of the planned shipments in Q2 to get pushed out to the back half of the year, is that how you guys are viewing it internally?

Gerrard Schmid -- President and Chief Executive Officer

I don't think that we expect the majority of shipments to get pushed out. You don't forget that our shipments are impacted based on how the virus has been moving around the world. So the Americas have felt less delays than some parts of Europe and as certain parts of Asia open up getting that positive effect. So this is done on a customer-by-customer basis.

We do expect and are seeing some push out into Q3 for units that are being produced in our factories right now, which is in part why we expect a slightly more challenging Q2. But we don't expect all of our units to get pushed out at all, Ishfaque. I think it will be spread and will be unique to customer by customer.

Ishfaque Faruk -- Sidoti and Company -- Analyst

Got it. Thank you, guys.

Operator

Thank you. We will now take our next question from Kartik Mehta from Northcoast Research.

Basel Kanaah -- Northcoast Research -- Analyst

Hi. This is Basel for Kartik. Gerrard, I just want to ask you a quick question. Just your perspective of which segment do you think is going to recover the first? And which region do you think will rebound the quickest between the global market based on your opinion?

Gerrard Schmid -- President and Chief Executive Officer

Yeah. I certainly have no better a crystal ball gazer than anybody else. And clearly, the big unknown is whether there's second wave of infections that causes a subsequent lockdown in different markets. So I think that's the big caveat that frames everything we're about to see.

But if we go back and take a look at the financial crisis of 2008 as one data point to think about, we saw less impact on banking than we saw in retail. And we're seeing a similar pattern play out this time around where retail gets a little bit harder hit than banking. So when I think about that, and I mentioned that in my comments, too, our banking segment has a higher proportion of services and software than retail, which is why I would expect it to be more resilient and potentially to rebound a little bit faster. But it's all going to be a function, quite frankly, of what happens in the next wave as different markets go through their own lockdown in reopening phases.

So until we all have a better handle on that, all I could say is provide those qualifying comments.

Basel Kanaah -- Northcoast Research -- Analyst

Great. Thank you. And do you think this will create a chance for you guys to grow market share as other players are facing more pressure and may exit the market?

Gerrard Schmid -- President and Chief Executive Officer

I can't kind of comment on the actions about this. What I would say is we're feeling very good about where we're at in terms of our competitive differentiation. There's no doubt that our services business is standing very toll right now. And we're extremely pleased with the service levels we're delivering, that proves the operational strength of our business model.

We're seeing, again, from customers no degradation in their interest in our DN Series machines. And in fact, recently, we've picked up some more purchase orders from banks that historically haven't bought hardware from us, which is a testament to their interest in the DN Series. And our software business is also showing some momentum. So net-net, we're feeling good about the progress we're making.

And I think that positions us well once we're through this.

Basel Kanaah -- Northcoast Research -- Analyst

Great. Thank you so much.

Operator

Thank you. We will now move to our next question from Barry Haimes from Sage Asset Management. Please go ahead.

Barry Haimes -- Sage Asset Management -- Analyst

Thanks very much for taking the question. I had a question about just sort of reconciling the free cash flow guide of about breakeven, compared with the prior number of $100 million -- $130 million. And it seems like you're actually doing more on the cost side, and the margin is OK. So is it fair to assume that most of that difference is expecting a lower top line compared to what you thought prior? Any color there would be great.

Thanks.

Jeff Rutherford -- Chief Financial Officer

Yeah. This is Jeff. We run multiple models and we run bottoms up, we run analytical models, we run black swine models, we run them all, right? And then we look at it from a cash flow perspective and what levers we can pull. So what the expectation would be is there's going to be some impact to the top line based upon the discussions we had relative to products being moderately impacted.

And then the margin fall through from that. And then we offset that with some of the actions we're taking and cost reductions. And then from a cash flow perspective, we're being very aggressive relative to reducing capital expenditures. We're going to only spend critical capital expenditures that impact customer contracts or customer obligations.

And then what we're going to be doing is monitoring very closely our working capital and assuring as from a previous question that we don't have slippage in DSOs, that we maintain our DPOs, and that we -- in particular, we don't build inventory, right? That's where we have a primary focus. So all those things in concept and all the models we run, we see a path to at least breakeven free cash flow. So that's what we're talking about here in our various modeling scenarios, continuing to monitor working capital, continuing to monitor capital spending to continue to pursue either long-term or short-term expense reductions. All those things in concert give us the confidence of breakeven free cash flow.

Barry Haimes -- Sage Asset Management -- Analyst

Got it. So it sounds like just to -- just one quick follow-up. It sounds like the breakeven free cash flow is an expectation in most of the scenarios, and it could be possible to do better than that. Is that a fair read?

Jeff Rutherford -- Chief Financial Officer

Yeah, that's right. We're going to pull the levers to preserve liquidity and to expand free cash flow wherever we can. That's the focus of -- and as I said earlier, the good thing is this management team is completely focused on that. And we don't have to build that muscle.

That muscle exists because of where we've been for the last two years.

Barry Haimes -- Sage Asset Management -- Analyst

Great. Thanks very much. Appreciate it. Good luck.

Operator

Thank you. We will now move to our next question from Rob Jost from Invesco. Please go ahead.

Rob Jost -- Invesco Senior Loan Asset Management -- Analyst

Hi. Thanks. Wanted to follow-up actually on that last question and just make sure I understood the free cash flow expectation. On Slide 15, there's a footnote that it excludes non-GAAP, right? So what I guess I'm wondering what the add backs, what the magnitude of add-backs would be free cash flow to get to like a real free cash flow?

Jeff Rutherford -- Chief Financial Officer

Oh, no, no. That's the real free cash flow. What's included in there from a non-GAAP perspective, is it picks up any -- anything that's non-GAAP that we take out, and we supply the schedule showing the non-GAAP adjustments, right, anything in there that's cash flow is included in that free cash flow. The only thing that's not included in that would be any cash effect, gain or loss from divestitures.

And yes, so it does say it's non-GAAP. But for example, let me give you an example, is -- we will -- from finance transformation, you'll see in the reconciliation of non-GAAP that under the restructuring accounting rules, we recognize now for expense purposes, the severance costs associated with the headcount reductions that we're executing on, and also the costs associated with the process of moving some of those -- or those processes to third parties. So we incur those costs, too. Those types of costs, although we take them out as non-GAAP, we do include the cash effect in our free cash flow.

So free cash flow on operations -- yes, the only thing that's not in free cash flow, and we also disclose it is anything outside of what we define as free cash flow, but we included a change in net debt, and that change in that debt schedules in there. And as I went through in the prepared remarks, what's in there is currency adjustment on cash and any effect from divestitures.

Rob Jost -- Invesco Senior Loan Asset Management -- Analyst

OK. Super helpful. OK. And then my second question is around the DN Series.

And I know the environment is causing a bit of delay in, I guess, the uptake. Could you put some numbers around that, help me to understand? So if you're going into the year and your expectation was, say, 100% of whatever number, what are you looking at today in terms of that given some of the pushouts and especially with the certifications taking longer than expected?

Gerrard Schmid -- President and Chief Executive Officer

Yeah, Rob, I think I'll frame it primarily by saying, if you go back and look at our prior comments, we always had a view that the DN Series was going to be more of a back end H2 event for us as customers have worked through their certification processes. So as some of those certifications are delayed, we may see some of those orders tip into 2021. I will tell you that we're not overly uncomfortable with that outcome. Earlier on, both Jeff and I commented that there were select work streams as part of our DN Now initiative that are seeing modest delays and DN Series happens to be one of those.

So the full-year impact on 2020 is actually quite modest given the staging of how these orders were lining up.

Rob Jost -- Invesco Senior Loan Asset Management -- Analyst

OK. Appreciate that. Thanks.

Operator

Thank you. And we will now take our last question today from Matt Summerville from D.A. Davidson. Please go ahead.

Matt Summerville -- D.A. Davidson -- Analyst

Just two quick follow-ups. Gerrard, can you maybe talk about the sustainability of the improvement you saw in software margins in Q1, I think, up almost 1,300 basis points year over year. And then also, I believe on your last call, you had commented that the company was budgeting some $25 million, I believe. Is it related to incremental growth investments? How you're sort of thinking about that as well? Thank you.

Gerrard Schmid -- President and Chief Executive Officer

Yeah, Matt. So as it relates to software, as you're well aware, large licenses in any given quarter can move the mix around. So I would just start with that comment. That being said, when you look at the timing of our various DN Now initiatives, our software excellence program is one of the key ones that we expect to ramp throughout 2020.

And we do expect it to drive increased margins in our software business, largely, as we look at billable utilization of our professional services resources and where and how we deploy our software capabilities. So it's a while -- I don't want to use any one quarter as a data point, we are fully expecting an improvement in our software margins due to those factors. In terms of the incremental growth initiatives, as I mentioned in my earlier comments, we do believe that coming out of COVID-19, banks, in particular, will have a heightened interest in managed services-related activities. And we continue to invest in those actions to make sure that we're well-positioned for COVID-19.

We have trimmed the investment level modestly. But as Jeff said earlier on, we continue to focus on protecting the customer-oriented growth initiatives. And where we have trimmed up capital investments, it's been primarily on internal systems.

Matt Summerville -- D.A. Davidson -- Analyst

Got it. Thank you.

Operator

I would now like to turn the call back to Steve Virostek for any additional closing remarks.

Steve Virostek -- Vice President of Investor Relations

Good. I just want to thank everybody for participating in today's call. And if you have follow-up questions, encourage you to contact me at Investor Relations. Thanks, everybody, and have a terrific day.

Operator

[Operator signoff]

Duration: 64 minutes

Call participants:

Steve Virostek -- Vice President of Investor Relations

Gerrard Schmid -- President and Chief Executive Officer

Jeff Rutherford -- Chief Financial Officer

Matt Summerville -- D.A. Davidson -- Analyst

Paul Coster -- J.P. Morgan -- Analyst

Unknown speaker

Ishfaque Faruk -- Sidoti and Company -- Analyst

Basel Kanaah -- Northcoast Research -- Analyst

Barry Haimes -- Sage Asset Management -- Analyst

Rob Jost -- Invesco Senior Loan Asset Management -- Analyst

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