NCR Corporation
Q3 2016 Earnings Call Transcript

Published: 26 Oct 2016

[Operator:]

Good afternoon. My name is Ben and I'll be your conference operator today. At this time, I'd like to welcome everyone to the NCR Corporation's Q3 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to Michael Nelson, Vice President of Investor Relations. Sir, you may begin your conference.

[Michael G. Nelson:]

Good afternoon and thank you for joining our third quarter 2016 earnings call. Joining me on the call today are Bill Nuti, Chairman and Chief Executive Officer; Mark Benjamin, President and Chief Operating Officer; Bob Fishman, Chief Financial Officer; and Paul Langenbahn, Senior Vice President and President, Hospitality. Before I turn the call over to Bill, let me remind you that our presentation and discussions today include forward-looking statements. Forward-looking statements reflect our current expectations and beliefs, but they are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties are described in our earnings release and our periodic filings with the SEC, including our Annual Report. On today's call, we will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their most directly comparable GAAP measures in today's presentation materials and on the Investor Relation's section of our website. A replay of this call will be available later today on our website ncr.com. With that, I would now like to turn the call over to Bill.

[William R. Nuti:]

Thanks to all of you for joining us today. I'll start with some brief opening remarks, Bob will take you through the numbers and our guidance, and Paul Langenbahn will provide some color on our solution revenue, key metrics and market drivers. Overall, NCR had a terrific Q3. In the 11 years since I've joined NCR, I have never felt better and more confident about our business. We entered the quarter with strong momentum and through solid execution, returned that momentum into healthy revenue growth across all of our business segments. Some major highlights for the quarter included a 7% increase in Software revenue, including software license growth of 26%, and impressively, cloud growth of 6%. Services grew 6% and Hardware revenue was higher by 16%. We are seeing the volume growth that we predicted in prior quarters with the main drivers of growth being omni-channel software, channel transformation and digital enablement solutions. As expected, we also experienced solid operating margin expansion as a result of Software revenue growth and improving productivity. We were also pleased to see the expansion of our Services margins in the quarter. Taken together, these results speak to the benefits of the diversity of our business both in terms of Software, Services and Hardware as well as our leadership position in the expanding omni-channel market. The reality of how consumers interact and transact their business today is something that we saw coming many years ago. Today, NCR offers complete end-to-end solutions that help our customers address rapidly changing consumer expectations and behavior while helping them to increase revenue and lower their cost. The value we deliver to our customers regardless of size or industry has never been stronger. Recently announced strategic wins like Papa Murphy's, Rutter's Farm Stores, Pen Air Federal Credit Union and Coles Supermarkets are clear examples of these offers gaining traction across multiple industries. As a result, I'm particularly pleased at our higher profit outcome coupled with our ongoing commitment to building a stronger and more efficient NCR helped drive strong free cash flow results in the quarter. And we remain on track to achieve our full year 2016 free cash flow goals. Lastly, NCR strengthened its executive leadership bench through the addition of Mark Benjamin as President and Chief Operating Officer. Mark has a great track record of results, is a well-known leader in the industry and has vast experience with recurring revenue models including cloud-based services. I'm excited about the value he can bring to both NCR and our customers as we continue to build operating momentum and a keen focus on execution remains our top priority. Now, I'll turn the call over to Mark for a few words. Mark?

[Mark D. Benjamin:]

Thank you, Bill, for the kind words. I am truly honored to join NCR, a company with an incredible record of success, innovation and vision that began nearly 135 years ago. NCR has built the unique platform through foresight, strategic focus, and a deep understanding of the many ways technology and consumer behavior is fundamentally changing the nature of transaction. As I learn more about today's NCR, I was equally impressed with NCR leadership team's drive and focus to win in our market, our strategic focus on omni-channel, and our unwavering focus on NCR's associates and customers. I strongly believe in the service-profit chain which is defined as there being a strong and direct relationship between employee satisfaction, to customer loyalty and to the ultimate profitability of the company. Simply stated, an engaged workforce will define our success measured by our customers and our shareholders. I have only been here for a couple of weeks but already have seen many examples of the value of our solution, product, and people bring to customers across all of our end markets and around the world. The omni-channel market is here and is maturing and NCR has built a strong leadership position. I'm looking forward to working with the entire NCR team as we leverage our innovative omni-channel software, channel transformation and digital-enablement capabilities and offerings and execute against our long-term growth strategy. Now, I'll turn the call over to Bob and he'll take you through the details of our Q3 results and guide. Bob?

[Robert P. Fishman:]

Thank you, Mark. Slide four shows our financial highlights for Q3. Revenue was up 10% on an adjusted constant currency basis. As a reminder, this is after normalizing for FX and the sale of our IPS business earlier this year. FX had a negative impact of only $5 million in the quarter, while the sale of IPS had a $79 million negative impact or 6%. We were very pleased with our revenue performance in the quarter which again came in over the top end of our guidance range. This was driven by strong performance in all three of our segments

[Paul Langenbahn:]

Thanks, Bob, and good afternoon everyone. I'll start on slide 15 which offers an overview of NCR's strategic offers within the omni-channel market. While the omni-channel market continues to evolve, our early mover advantage, strategic foresight and deepening understanding of the underlying market forces continues to position us for success. Our conversations with customers today are increasingly dominated by omni-channel not being a thing of the future but instead a daily reality that impacts their ability to compete and win share against a backdrop of disruptive competition, shifting consumer demands and digital empowerment. NCR today is a leader in three key areas of the omni-channel market

[William R. Nuti:]

Thank you, Paul. In summary, a solid Q3 places us as positioned to continue executing against our full year goals and get off to a fast start in 2017. Our global leadership in omni-channel software, channel transformation and digital enablement is differentiating NCR and winning us business every day. That is clearly demonstrated by our Q3 results as well as strong backlog and business metrics. NCR stands at the forefront of helping customers both address major global trends that are reshaping how industries interact with consumers as well as secure productivity gains and cost efficiencies that best position them to compete in a rapidly changing world. Moving forward, our goals are clear. Continue to drive improved execution, further grow our backlog volume (32

[Operator:]

Our first question comes from the line of Matt Summerville from Alembic Global Advisors. Excuse me, Paul Coster from JPMorgan.

[William R. Nuti:]

Hey, Paul.

[Paul Coster:]

Yeah, thanks very much for taking the question. I guess the first question is, maybe I got lost in the details a bit here, but what were the big takeaways in terms of backlog and orders this quarter, and how does that compares to, say, the same time last year?

[Robert P. Fishman:]

Yeah. Hey, Paul. We had a strong quarter in terms of orders. Orders grew high-single digits for us in the quarter. And then we go into the fourth quarter with backlog up low-double digits. So that's good news for us, Paul. It positions us well for good growth in Q4 revenue. We gave guidance of 8% to 10% for Q4 revenue. So again, very pleased with topline growth in the third quarter and continued guidance for Q4.

[William R. Nuti:]

And Paul, I'd only add that software growth in orders were strong right? Was up how much?

[Robert P. Fishman:]

Yeah. Software growth was up around 12%, Paul. And backlog for software was up roughly 10%.

[Paul Coster:]

Right. And, of course, that's recurring in nature, much of it.

[William R. Nuti:]

Yeah.

[Paul Coster:]

Okay. And the other question I've got is, kind of playing devil's advocate here. Isn't this kind of a bit of a fluke-ish year? You've got – your nearest competitor engaged in M&A, you've got the ramp in bank transformation and it probably doesn't get much better than the rate of growth you've seen there this year. And you have this new product on the ATM side that – for which there was pent-up demand. Can this really be replicated in 2017?

[William R. Nuti:]

Paul, look, I think this is the strongest momentum I've seen in my 11 years as CEO. In fact, the order growth in Q4 will probably be in excess of 40% year-over-year, and really well-balanced across every industry, every market. And really when you peel the onion back, it's about omni-channel growth. But maybe Andy or Michael or Paul give a perspective on that.

[Michael Bayer:]

It's Michael Bayer speaking.

[Andrew S. Heyman:]

Well, I would say on the – go ahead. Go ahead, Michael.

[Michael Bayer:]

Thank you, Andy. Let me talk a bit about the momentum Bill was alluding to. Already in March, we talked about channel transformation, which for us in retail is called store transformation, as an area of growth. The orders have grown since Q4 2015, throughout the whole year this year. So we are now seeing the same moving forward as some of our customers are getting ready in preparing themselves for rollout starting in February 2017. It's about new markets, it's about new customers, but it's also about existing customers who are starting to build their own roadmap jointly with us, how to increase the density and how to change the experience of their consumers. So, to us, this is really a longer-term trend. It was – this year, to us, was the starting point of all of the things coming together. Andy, go ahead, please.

[Andrew S. Heyman:]

Thanks, Michael. The thing I would say directly to the question you asked, Paul, about pent-up demand, which, I think, one of the things you're referring to is the 80 Series launch, which has been highly successful for us. In the 12 months leading up to the Q3 scale of launch that we've had, we were still out there winning share in total, albeit by small amounts, but still winning shares. So this has been quite additive for us, number one; and number two, based on the funnel that we're looking at, we do not see it at all as a one-time event.

[Paul Coster:]

Thank you very much.

[William R. Nuti:]

Thank you, Paul.

[Operator:]

Your next question comes from the line of Matt Summerville with Alembic Global Advisors.

[Matt Summerville:]

Hey. Thanks. Couple questions. First, I want to talk about kind of the incremental operating margins you're seeing in the businesses in which you report. First, with Software, you have kind of a total operating margin in the low-30s, incrementals not all that much different. I guess, you're seeing constant currency revenue growth of 7%. What has to happen for those incremental margins to move meaningfully higher above kind of the segment average? I would assume there's some degree of scale that has to play into here. If you can help kind of bridge that gap, that would be helpful.

[Robert P. Fishman:]

Yeah. Matt, no doubt that that's a big opportunity for us. When we look at our gross margins within the Software business, we think there is significant opportunity primarily in the cloud business and software maintenance. Those were the major findings coming out of the work earlier this year with AlixPartners. So when we look at our margins compared to our competitors, we're probably 1,000 basis points below where they are at. So two big projects coming out of the work earlier this year that will start to benefit us next year is around building the efficiency in those two spaces. But no doubt that volume helps the cloud business. So we were extremely pleased to see the cloud growth in the quarter, up 6%; the net ACV bookings are tracking well, which bodes well for future growth. So layering on higher growth, improving the efficiency in cloud and software maintenance, that's the key to improving those operating margins.

[Matt Summerville:]

And then as a follow-up, conversely, your incremental margins, and I look more just at the operating income line. In Services, we're actually pretty good at about 25%. Even if you adjust out for currency on the Hardware side of things, you don't have the IPS business anymore, so I assume it would not be all that much of a money-making business for you guys, not a lot of leverage on the hardware side. So talk about what's going well on Services and why was the ATM business up double-digits, self-checkout up almost double year-over-year, there's just no operating leverage?

[Robert P. Fishman:]

Yes. Services for us is an exciting opportunity to not only improve the customer experience, but to expand the margins. So a lot of that has to do with the technology place, the investments we've made, it's around remote and predictive, it's around centralizing our call center. So those are all investments that we've made that we're going to continue to benefit from going into 2017. So a lot of opportunity within the Services margins, a lot of that was technology investments that we've made. Within Hardware, it does come down to mix to the business; no doubt that self-checkout business helps the margin, but, overall, as we ramp our new product introductions, you'll see that Hardware operating margin improve.

[William R. Nuti:]

Hey, Matt. The only other point I'd make is that remember for us, there is significant attach of high-margin revenue for every dollar of Hardware we ship. So now we're looking out in 2017 and 2018, and for every dollar of hardware we ship now there is about $2 of attach, services attach, PS attach and software maintenance attach as well as one-time implementation services attach. So the good news of our Hardware growth is that long term it benefits our higher margin recurring revenue chain.

[Matt Summerville:]

Thank you guys.

[Operator:]

And the next question comes from the line of Ian Zaffino from NCR (sic) [Oppenheimer].

[Daniello Natoli:]

Hi. It's Dan Natoli in for Ian. Just a quick question on the self-checkout. Given a lot of the weakness that you see in retailing and other parts of the market, would you say – where there certain sectors within retail or subsectors that were more driven to the self-checkout or is it pretty much across the board, across all the retailers across the board?

[William R. Nuti:]

Relatively broad-based. Michael, go ahead.

[Michael Bayer:]

Yeah. As Bill said, it's broad-based. And it is not the self-checkout itself, it's really around the full self-checkout experience for your customer. It can be mobile, it can be mobile in conjunction with the self-checkout unit, in-aisle checkout, mobile checkouts for the employees, mobile point-of-sale; we've seen all of these numbers growing. So it is really a trend where the customer – where our customers are taking the theme of channel transformation for their consumers serious, and it comes hand-in-hand then with the software supporting that all around the omni-channel software items Paul Langenbahn talked about, like loyalty, like e-receipts like web connect. So the whole play which we've talked about over the last two years has much faster accelerated than we assumed, and we are buildings those roadmaps with our customers around the world. Maybe one last point from me to mention; one of the accelerating factors is actually the availability of labor. So if you think about the top 100 cities, 200 cities around the world that commute for the employees becomes longer and longer in terms of the affordability of living in the city. So all of a sudden, you have a lack of labor. And so the lack of labor is addressed through automatization which was something, which I would say was an add-on to our business cases in the way we positions toward transformation.

[Daniello Natoli:]

Great. And then just a follow-up. Do you see the self-checkouts still maintaining those high double-digit year-over-year growth rates?

[Andrew S. Heyman:]

We are seeing positive growth rates. I'm not so sure what the growth rate in essence will be, but we are not seeing a slowdown as we are having three components driving this growth. We have new countries coming to play due to the situation around labor availability in the top cities. We have new customers coming to play. We see more DIY also around the globe looking into self-checkout as well as our big volume convenience customers looking into our smaller form factors of self-checkout in the outside payment and interaction terminals. And then we have new countries coming to play. We are getting more and more reach in Russia, Southeast Asia and Latin America. So that kind of gives me a positive view on where we're going to take this.

[Daniello Natoli:]

Great. Thank you.

[Operator:]

I would now like to pass the call back to Bill Nuti for any closing remarks.

[William R. Nuti:]

Thank you all for being here today. We'll see you in February. Bye-bye.

[Operator:]

This concludes today's conference call. Thank you for your participation. You may now disconnect.