NCR Voyix Corp (VYX) 2018 Q3 法說會逐字稿

Good day, and welcome to the NCR Corporation Third Quarter Fiscal Year 2018 Earnings Conference Call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Mr. Michael Nelson, Vice President of Investor Relations.

Please go ahead, sir.

Good afternoon, and thank you for joining our third quarter 2018 earnings call.

Joining me on the call today are Mike Hayford, President and Chief Executive Officer; Owen Sullivan, who joined NCR 3 months ago as Chief Operating Officer; Andre Fernandez, who joined NCR 2 months ago as Chief Financial Officer; and Frank Martire, Executive Chairman.

Before we get started, let me remind you that our presentation and discussion will include forward-looking statements.

These statements reflect our current expectations and beliefs, but they're subject to risks and uncertainties that could cause actual results to differ materially from those expectations.

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 GAAP counterparts in the presentation materials and on the Investor Relations page 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 Mike.

Thanks, Michael, and thank you, everyone, for joining us today for our third quarter 2018 earnings call.

I will begin with some of my views on the business before turning it over to Owen, who will provide an update on our operational improvements; and then Andre will review our financial performance during the quarter.

Then Owen, Andre, Frank and I will take your questions.

We'll begin on Slide 3 with a brief overview of our financial and operating performance.

Our third quarter results were largely in line with our expectations, and we continue to focus on improving operational execution.

Two areas of strategic emphasis we've noted are expanding our recurring revenues and driving Cloud revenue growth.

During the quarter, recurring revenues increased 2%, which represents 48% of total revenue, while Cloud revenues were up 6%.

Also, the consistent implementation of our M1 initiative is driving further margin expansion in Services as gross margin reached 26.8% in the quarter, up 70 basis points compared to last year.

Improving our margin profile in Services will remain a key priority.

Last quarter, we spoke about a number of critical areas where NCR needs to improve in order to elevate the value we offer our customers.

We are addressing those execution challenges, and we will provide an update of our progress in a few minutes.

We've also been hard at work redesigning our manufacturing network and alleviating supply chain constraints.

Our success to date has us on pace to deliver a meaningful increase in ATM production during the fourth quarter.

In addition to our previously announced M1 initiatives on Services and our manufacturing restructuring plan, we have identified additional cost savings opportunities that are expected to result in at least $100 million of savings in 2019.

Andre will cover this in more detail in his section.

On our last call, we shared our capital allocation strategy.

We remain focused on adding products to our sales and distribution network to increase our sales to existing markets.

To achieve this, we referenced the need to use a targeted M&A program to execute that strategy.

Last week, we announced our entry into payment via the pending acquisition of JetPay.

We continue to take a disciplined approach to capital allocation and seek targeted M&A that will accelerate our mix shift to more software, Services and recurring revenue.

I'll discuss our recent acquisitions in a few minutes.

First, let's move on to Slide 4 and review the top strategic priorities we shared on our second quarter call.

It all begins with taking care of our customers.

NCR has built a large established global customer base that includes blue-chip names across the financial, retail and hospitality sectors.

We are a critical business partner and solutions provider to our customers, and continue to focus on several key execution areas, including new product introductions and providing the highest-quality products to market in a timely fashion.

These execution challenges are the drivers behind our second key priority: innovate and bringing high-quality solutions to the market faster.

We have moved swiftly to improve quality and accelerate solutions deployment, including through our dedicated accelerated customer activation teams, or ACAT, which Owen will discuss in more detail.

The third key priority is to streamline our business and eliminate organizational silos and processes that delay our time-to-market.

This priority is designed to elevate the customer voice and enable faster development and deployment of solutions.

The result should be speed to market, provide competitive advantage to the marketplace and ultimately, drive accelerated growth.

Strengthening our growth profile is our fourth and most important priority.

We will execute on these priorities in a diligent manner, not just on products and organizational side, but on the cost side as well.

We are actively managing our costs, as evidenced by the cost reduction initiative, while also allocating spend to the highest-growth opportunities we see across our markets.

We are focused on expanding our recurring revenues, and driving profitable growth through cash flow expansion.

And as we've demonstrated by the JetPay acquisition, we will implement a targeted M&A program that expands our market, diversifies our revenue streams and strengthens our solutions offering.

I will speak to each of our recent acquisitions on Slide 5.

Last week, we announced a definitive agreement to acquire JetPay, which will expand NCR's offering into the high-value payments space and allow us to monetize transactions via payment.

JetPay is a provider of end-to-end payment processing.

This acquisition will give NCR powerful new products to sell as a provider of end-to-end integrated point-of-sale and payments platform.

NCR will be able to use JetPay's innovative payments platform to deliver turnkey, highly integrated point-of-sale and payment bundles to our customers.

JetPay provides us entry into payment processing while also accelerating our growth, driving recurring revenue streams, and shifting the mix to more software and Services, consistent with our strategy.

It also enhances the value proposition we bring to our customers, again, consistent with our priorities through specialization, simplicity and bundled functionality.

The purchase price of roughly $184 million represents 2.9x revenue and is expected to be accretive with EPS within 12 months of closing.

During the third quarter, we also completed the acquisition of Zipscene, a data analytics company.

Zipscene aggregates data from restaurant customers buying patterns and provides targeted marketing data back to the restaurant.

This enables NCR to begin monetizing the wealth of data we collect through our enterprise point-of-sale platform.

We are excited about the additions of JetPay and Zipscene and believe they are consistent with our strategic mandates: expand our recurring revenues, shift the mix to software and Services, and bring high-quality solutions to market to take better care of our customers by helping enable their success.

With that, let me pass the call over to Owen.

Thank you, Mike.

Moving to an update on our efforts to redesign our manufacturing network on Slide 6. We continue to take necessary actions related to our manufacturing and distribution network as we execute on our strategy to accelerate our transformation to a software- and Services-led company.

Since my arrival, I've had the opportunity to visit our facilities in Nashville, Columbus, Mexico and Budapest.

During those visits, I met with our new third-party partners: Jabil on the manufacturing side and CEVA on the distribution part of our business.

Our progress across the network has been significant, and I am confident we will achieve the benefits we set out to accomplish.

To date, the team has delivered on key milestones.

First, we recently opened a new third-party logistics warehouse with CEVA to help facilitate improved distribution and optimize our supply chain and logistics flow.

Second, we have begun a significant ramp of our manufacturing production with Jabil in Chihuahua and USI in Guadalajara.

The benefit to be received with these third-party partners is the ability to ship from a largely fixed cost structure to a more variable structure, thus mitigating our P&L exposure to hardware demand cycles.

Both these partners have increased their production and are on track to deliver to meet our fourth quarter demands.

With the closing of our Beijing plant as well as 2 additional facilities by year-end, we will deliver overall improvement in our global utilization rates.

The supply chain constraints related to the ATM 80 Series have largely been resolved.

We are significantly ramping production to meet the stronger-than-anticipated demand our 80 Series has generated and are working through our increased backlog.

Overall, we've made steady progress on our hardware transformation initiatives.

Our focus now needs to heighten, as we execute on these initiatives, beginning in the fourth quarter.

We are making progress to strengthen our global competitive position and overall cost structure, and best position NCR for improved profitability and cash flow production in the years ahead.

You will get a clearer picture of the progress we are making on Slide 7, which shows the significant increase in ATM production in the third quarter as well as the expected ramp in the fourth quarter.

Given the strong demand in backlog for the ATM 80 Series, we moved quickly to identify and eliminate supply chain constraints, engage our contract manufacturing partners and drive increased global utilization of our manufacturing assets.

This slide shows the significant ramp in production we achieved from Q2 to Q3 as well as the additional increase we expect during the fourth quarter.

Our plan to improve our manufacturing operations is progressing, and we expect production levels to finish the year strong.

This heightened production level will be supported by our improved supply chain logistics and distribution operations.

During the third quarter, ATM orders were up 10%, and backlog was up roughly 30% year-over-year.

We exited the third quarter with production levels in September needed to achieve our fourth quarter targets.

Turning to Slide 8. We will provide an update on our accelerated customer activation teams or ACAT.

Last quarter, we discussed that we created 5 cross-functional SWAT teams focused on improving execution around our new product introductions.

The teams are focused on bringing 5 key strategic solutions to the market.

The solutions include: interactive teller; consumer self-ordering; NCR OPTIC for convenience and fuel retailers; Emerald, our next-generation retail software solution; and self-checkout Release 6. These teams were formed mainly as part of our efforts to bring better solutions to market faster, and ensure that the needs of our customers are better addressed.

I had the opportunity to spend time with these teams in Atlanta, Dundee, London and elsewhere.

The benefit of aligning our resources around the critical offering with a common goal of client satisfaction has served our team well.

Each team has met or exceeded its delivery timeframe commitment, has implemented their offering at a customer site, and each has multiple client references and are excited to aggressively bring the offerings to market.

These successes serve us well as we continue to look at how we organize and execute to serve our markets and clients more successfully going forward.

With that, let me pass the call over to Andre.

Thank you, Owen.

On a personal note, it's great to be here at NCR, and I look forward to meeting many of you, both at our upcoming Investor Day on November 7, as well as in the coming weeks and months as we lay out our strategic direction for the business.

Moving first to Slide #9.

In my first 60 days in the role, our management team and I have spent a significant amount of time analyzing our business and cost structure and optimizing our spend.

As you already know, our M1 initiative in our Services business has resulted in solid topline and margin performance in that segment.

Our Hardware and network redesign is also making significant progress, as Owen discussed.

The initiatives we are taking in our manufacturing operations, while adversely impacting 2018, will result in a more efficient operation, and improved profitability in our Hardware business in 2019.

In addition to these efforts, we recognize that both our SG&A as well as our overall operating expenses have increased as a percentage of revenue.

In response, we have identified additional cost reduction opportunities in nonstrategic areas in our corporate functions, and in sharply curtailing discretionary spending across the company.

While we are still finalizing the impact, we expect these actions will generate at least $100 million of annualized savings in 2019, with some of that savings beginning here in the fourth quarter.

On a cash basis, we expect the cost to be in the $75 million to $100 million range, which will be paid in both 2018 and 2019.

As you've seen in our earnings release and I'll discuss again later, we've lowered our free cash flow estimate for the full year 2018, in part due to the expected cash usage in association with these actions.

Now having reviewed prior earnings calls, I know that there have been a number of previously announced restructurings, including in the first quarter of this year.

While we've seen the positive impact of such actions in our Services segment in both revenue and gross margin, the impact in our Hardware business, along with the total overall savings to the company, has not been as clear.

In subsequent earnings calls, beginning with the fourth quarter, I'll be sure to update you clearly on the ongoing impact of these actions on Hardware and Services, which were largely gross margin driven as well as this latest action, which is more targeted at SG&A and improving our operating margin.

We believe these cost actions will address some of the cost creep we've had in recent years, and result in a more focused organization that is better positioned to drive margin expansion and to create long-term shareholder value.

Turning now to Slide 10.

Revenue for the fourth quarter was $1.55 billion or down 5% on a constant currency basis.

The decline was driven by our Hardware segment due to supply and capacity constraints that improved over the course of the quarter.

I will discuss this more thoroughly when we move to the Hardware segment.

But had we resolved our manufacturing constraints earlier in the quarter, and were able to convert our backlog at the same rate as last year, our revenue for the quarter would have been slightly positive on a constant currency basis.

FX was a $32 million headwind this quarter given a stronger U.S. dollar relative to other currencies, particularly in developing markets where we have meaningful operations.

As Mike mentioned previously, recurring revenue had another solid quarter, representing 48% of total revenue and grew 2%.

Gross margin rate was down 170 basis points constant currency in the quarter.

Services margin continued to expand, but was more than offset by declines in Software and Hardware margins.

Non-GAAP diluted EPS was $0.58 in the quarter, and FX was a $0.03 headwind as compared to rates a year ago.

The year-over-year decline in EPS was primarily due to lower revenue, margin pressure on hardware, and continued investment to improve execution.

Free cash outflow in the quarter was $22 million, primarily due to lower earnings, but as you know, is expected to improve seasonally here in the fourth quarter.

Moving on now to each of our segments.

Slide 11 shows our Software segment results.

Cloud revenue was up 6% in the quarter, with net ACV of $10 million.

Software license revenue was up 3% constant currency, primarily due to higher unattached sales, offset by lower attached Software license revenue due to declines in Hardware.

We expect an increase in attached Software license revenue in the fourth quarter related to the expected ramp in ATM revenue.

Operating income was down, driven by higher third-party software content as well as continued investment in the business, partially offset by margin expansion in Cloud.

Moving on now to Slide 12, which shows our Services segment results.

Revenue was up 4% constant currency as we continue to benefit from managed service offerings, channel transformation trends and improved customer satisfaction.

Services margin continues to expand, driven by our Mission One initiative that's improving productivity and efficiency.

Now to Slide 13, which shows our Hardware segment results.

Revenue was down 20% constant currency in the quarter, with ATMs down 10%, point-of-sale down 28% and self-checkout down 24%.

ATM revenue was in line with our expectations, as we continue to work through our supply constraints, including key parts shortages due to the transition from our ATM 30 Series product line to our newest ATM 80 Series product line.

By the end of the quarter, we had made great progress towards resolving the supply constraints, which were unrelated to our transition to contract manufacturing.

Also, as I mentioned previously, had we converted our backlog at a similar rate as last year, our total revenue would have grown in the quarter.

We continue to experience strong ATM orders, which were up 10% year-over-year and were up for the third consecutive quarter.

We view this as a positive sign of increased demand for our new ATM family, and should result in meaningful ATM revenue growth in the fourth quarter.

Self-checkout revenue was down in the third quarter after being up in the second quarter of the year.

The decline is largely due to the timing of customer rollouts.

Point-of-sale revenues were lower in the quarter compared to growth of 18% last year, which also benefited from several large customer rollouts.

Hardware gross margin was down significantly in the quarter due to lower overall revenue and unfavorable product mix, some pricing pressure, and higher costs associated with improving our manufacturing and distribution operations.

Had we converted the backlog at a similar rate as last year and excluding nonrecurring costs in such areas as expediting and warehousing, Hardware operating income would have been closer to breakeven in the third quarter.

Returning Hardware to profitability is a primary objective of the company.

The initiatives we are taking to redesign our manufacturing network and improve supply chain logistics will improve profitability over time.

Slide 14 shows our free cash outflow for the third quarter and year-to-date.

These outflows are primarily due to the lower earnings.

As a reminder, the majority of our annual free cash flow is typically generated in the fourth quarter.

Slide 14 also shows our net debt to adjusted EBITDA at the end of Q3.

We are at 2.8x, which is up from 2.5x as of Q3 2017 due to lower income from operations.

Slide 15 includes our full year 2018 guidance.

We continue to focus on improving execution in the current year to benefit 2019.

For 2018, we continue to guide reported revenue of minus 1% to minus 3%.

We expect Software revenue will be approximately flat, with Cloud revenue to grow roughly 6% to 7%.

We expect Services revenue to be up low single digits for the full year.

We believe that Hardware revenue will be down mid- to high single digits.

Our view of ATM revenue is unchanged at roughly flat for the year, and is supported by a strong backlog and orders growth for the year.

We continue to guide our non-GAAP EPS to $2.55 to $2.75.

As we focus on fixing our execution challenges, we expect improvements going into next year.

We have assumed a tax rate of 21%, OIE of approximately $205 million and a share count of 151 million.

The reconciliation of the GAAP to non-GAAP EPS is included in the supplementary schedules.

We expect free cash flow to be approximately $250 million to $300 million, down from $300 million to $350 million previously.

The decline in free cash flow is due to higher working capital associated with increased production to meet our strong backlog position as well as the cash impact of the spend optimization program announced previously.

Although we increased manufacturing production significantly in Q3, and will reach near-record levels in the fourth quarter, we still expect to end the year with growth in our backlog.

This will require higher working capital at year-end and result in seasonally higher production in the first quarter of 2019.

With that, I will turn it back to Mike for closing comments.

Thanks, Andre.

In summary, we are making clear progress executing on our key priorities while also addressing our supply chain constraints.

In addition, the acquisitions of JetPay and Zipscene will expand markets for NCR and our solutions, improve our Software and Services revenue mix and also help drive higher recurring revenues.

On the manufacturing side, we are working to improve our cost structure while also fulfilling the strong outstanding demand for our ATM 80 Series.

We will continue to emphasize cash flow generation and execute our balanced capital allocation strategy with targeted M&A.

I'm pleased with the success we've made to date.

However, much work remains to be done.

The passion and commitment of the entire NCR team is second to none.

And together, we will continue to serve our customers, deploy innovative solutions that drive business outcomes, and improve our cost structure.

Thank you for your time.

And now Owen, Andre, Frank and I will take your questions.

(Operator Instructions) And we'll take our first question from Dan Terlin (sic) [Perlin] of RBC Capital Markets.

So I had a couple of questions, if I could.

The one starts with managed Services, in particular around the community banks.

Are you already seeing impacts from the product that you rolled out, I want to say maybe 3, 4, maybe a month ago?

Yes.

On supporting the banks in terms of servicing and outsourcing, their back office you're talking about?

Yes.

You had -- part of the strategy was kind of create this -- as you called it a bundled solution for digital banking, managed Services for community banks as well.

And then obviously, once you fix the ATM issue, you could probably bundle that together.

And I thought that I saw you guys put out a release a few weeks back where you were already introducing kind of a Managed Services solution for community banks.

And I was wondering if they were already seeing signs of biting on that or not.

Yes, we -- I think that's a good point.

We're bundling together where we can the service component along with the hardware and along with obviously, the software for community banking.

So we've announced it.

We're getting a little bit of traction.

I don't think we've seen the numbers really start to tick up yet in that area, but I think we're excited not only in banking when we start bundling the service, but we obviously had a lot of success in the retail side, and we'll plan to do the same thing in hospitality going forward.

Okay.

On the JetPay acquisition, is the idea that you're going to be able to connect that to the Aloha solution, but also in other parts.

So I'm thinking NCR Silver and other parts of the Retail.

And I think in the past, there has been a slide.

You didn't put it out, Mike, but predecessors did where I think they said volume that NCR generated was about $120 billion in payment flows.

And I'm wondering are you expecting to be able to capture that much?

And is that still a good number?

Well, we'll update you on the number.

I'm not sure, I was using that one in particular.

I think the number could be even bigger if you look at the totality.

So clearly, Aloha where we're very sticky in the restaurants space and have a big market share to fully integrate the merchant acquirer with JetPay in the back end of that.

And again, our strategy will be to really make that tightly coupled with the uniqueness of the front-end POS that we have on the enterprise software.

So we'll do it with Aloha.

We'll do it with Silver.

We'll do it with products like our POS and convenient store, we'll do it in the retail space.

I think our plan will be wherever we have very strong penetration with a front-end enterprise software in a retailer and hospitality, we'll connect the payments and then settle through the back end on the merchant side.

So we're pretty excited about it.

We obviously have some work to get it up to speed, get it integrated, get it connected across all our platforms.

But the team is fully engaged.

We brought in some people with some payments background to help make that happen.

And one last quick one for Owen.

You said, Owen, the 80 Series supply chain has largely been resolved.

I know that's a nuanced way to say it.

But I thought there was kind of 3 issues in terms of the supply, the display screen and then there were 2 other ones a little bit smaller.

Have those all been resolved?

And then you're referring to just like a bigger issue around supply chain?

Or I know you can hit the number it sounds like, but I'm just wondering if all 3 of those issues were completed?

Right.

It's a fair question.

I didn't mean to nuance it that much.

I think we had talked earlier about there'd still be some noise in the system in the third quarter as we settled down the supply chain issues.

And in fact, there was, but we came out of the quarter with the supply chain issues addressed, and the production issues on the trajectory we need for the fourth quarter.

So we feel good that the noise is now out of the system relative to the supply chain.

[And I will follow up on] -- yes.

And our next question will come from Kartik Mehta of Northcoast Research.

Andre, I was hoping you might be able to look at the cost savings you talked about.

As you said, there have been a number of cost savings announced, obviously, previous to you becoming CFO.

And I'm wondering if you could just give a cumulative number, a comprehensive number for 2019 in terms of the cost savings you're anticipating.

Yes, Kartik, this is Mike.

Let me just start, then Andre can kind of fill in some more detail.

So there were literally -- obviously, we -- NCR announced in the first quarter some actions for 2018.

And those announcements were kind of a [feedback] on top of the prior year announcement that had recurring activities.

And so as we looked at that, we said, let's just focus going forward.

So looked at our numbers as we've seen them in 2018 second quarter, third quarter.

Obviously, our outlook for the year and rather try to tick and tie back to at least 2 prior initiatives and announcements, let's just focus on going forward.

So the way you should look at it is there is 3 distinct efficiency streams going on, the Services, M1 that we've announced in the past continue to execute.

And you can see the benefits for the M1 initiative in the Services numbers each quarter.

And we're continuing to make progress, continuing to get margin expansion.

And more importantly, our customer sat numbers are continuing to improve in that area.

We've got the Hardware transformation.

Owen spoke about that, the manufacturing shift.

The work that we're doing not only manufacturing, setting up 2 new plants through third parties in Mexico, but also a new distribution center up in Nashville.

That work is still under way.

That's been a cost drag for us in 2018.

We're continuing to work through the limitation in the fourth quarter.

So there's still work to be done on that.

We expect going forward in '19 that will drive some savings on the Hardware platform.

And then -- so then today we announced $100 million plus takeout of cost.

Andre talked about it being an overhead SG&A discretionary spending, just to bring those areas back in line with where we think they should be, they've seemed to creep over the last 2 to 3 years.

But take those 3 buckets, we're going to lay out -- we'll lay out our plan for 2019.

We give guidance.

We're not going to do that until fourth quarter call end of January, early February.

But we will give you where we stand on Services.

We'll give you where we stand on Hardware, and where -- what you should expect on this $100-plus million takeout additional cost.

Any other prior plan that was announced or underway, I don't try to tick and tie back to it, just look going forward those 3 cost efficiency paths.

Kartik, this is Andre, too.

I mentioned in my prepared remarks the first 2 are largely gross margin focused.

I think this third one, in answer to your -- response to your question was I came in and took a close look at our operating expenses, mainly SG&A.

And as you could look through the charts here in our webcast, you'll see the operating margin is deteriorating across the board.

So it's not just a gross margin issue.

It's an operating margin issue as well.

And I think we allowed some creep, particularly in our -- in SG&A over the last couple of years.

So this action, which is at least $100 million, is targeted at that largely.

It's SG&A and OpEx to address the fact the margin has probably fallen by about 3 points just over the last few years.

So as we thought it about next year, and when we talk to you at year-end for our Q4 call, I think the thought process was where do we want 2019 to be from a margin perspective.

Also addressing some cost headwinds that are coming at us, whether it's accommodating our people appropriately, addressing the cost of a new building we have here in Atlanta, and also going into 2019 is achieving cost reduction, but also freeing up resources that we'd like to reinvest in the business.

And you're going to hear about a number of those next week at our Investor Day.

So I think all of those went into our thought process, and also went into sizing of the magnitude of the action that we announced today.

And so Andre, are you able to talk about maybe what percentage of that $100 million or dollar amount of that $100 million you expect to fall to the bottom line?

No, I think we'll address that in the fourth quarter.

Obviously, as I said, we're going to take that at least $100 million, so we'll be in a position to further refine that.

But also, when we come to you and lay out 2019, we'd also like to lay out for you the areas that we'd like to reinvest in the business to give you the net number that you're looking for.

And then, Mike, you talked about ATM orders improving.

Maybe, could you talk about the geographies where you're seeing ATM demand?

And is this the result of Windows 10?

Or is this the result of something else?

I think our strongest has been North America.

We've had a great deal of success.

I think, actually, Asia's been pretty strong for us but a much smaller number.

I -- Windows 10, I think we got -- we've got our plan out there.

We got our sales team equipped to go out and sell the upgrade.

Of course, we're seeing that come in.

I don't know that I called that out as a huge driver.

I think our Series 80 is having great success.

What seems to be happening as it got out in the field last year at 2017 and other bankers have seen them in the field, we have people come in and say, "Wow, we saw that at another bank's site, and we really like the product." And they came in and made orders.

So that's continued to take off.

I think we've got a little bit of help from some of our competitors in the marketplace, and we've seen people come to us and have good dialogue, good discussions not only around ATM sales but also around service and support.

So I think we feel pretty good about where we stand.

Obviously, we've got to work through the manufacturing, which we largely did in the third quarter on the Series 80 supplies.

But I think we feel good about the orders and backlog.

And just one last question, Mike.

The Hardware business, where does it have to be in terms of a revenue standpoint or whatever other metric you'd like to use for that business to be breakeven?

Because if you look this quarter, the amount you logged from an operating income just year-over-year was greater than the revenue that was deteriorated year-over-year.

So I'm just wondering if there's a level you need to get to for that business to get to breakeven.

We talked about this last quarter that our -- we said second quarter is a little challenged on getting product out the door.

We knew we had some of that coming into third quarter.

So we know that based on the September success that the ramp-up into fourth quarter's happening, and so fourth quarter will be a fairly large revenue number compared to the second, third quarter.

We hope to approach breakeven in the third -- in the fourth quarter, sorry.

We talked about that with that volume, that'll drive, obviously, allocating our fixed cost across a greater number of units and get us close.

Our goal, clearly, with the Hardware restructuring, the transformation project we're undertaking just to get us in a position where, at various production levels, we can operate Hardware at breakeven or better.

And so that's what we're aiming towards.

I think we'll come pretty close in fourth quarter.

I don't know if we'll quite get to the positive side, but I think we'll get awfully close.

And then going into '19, we have to find a way that we don't lose the kind of money we lost in '18 on the Hardware products.

Kartik, I -- it's Andre.

I said in my prepared remarks, too, that if you just -- if we were just able to convert the backlog at the same rate that we did last year, and we know that exactly, plus some additional costs that we incurred in connection with resolving the supply chain constraints and some of the ramp-up, we would have had a breakeven Hardware operation in the third quarter.

So we see a path there.

We know what it takes.

I think, as Mike said, we're going to try to get as close to breakeven as we can in the fourth quarter.

We were a little bit negative at this time.

Last year, fourth quarter, we're going to -- we're hoping we can get close.

And then I'm going -- as I said in my prepared remarks and Mike said as well, we want to try to run this at least at breakeven, if not, better.

And we'll now hear from Katy Huberty of Morgan Stanley.

A couple questions for me as well.

First, on ATM, to hit that target for flat ATM revenue growth for the, year 2018, it requires growth in the rates of 30% in 4Q.

I just want to check if that's reasonable.

And then just as a follow-up to that one, the fourth quarter, I believe, [you've done] some catch-up shipments to address the backlog.

So how should we think about what the sustainable growth rate is as you get into 2019 and look at the 10% order growth in that as a proxy for what next year [is going to look like]?

Yes, Katy, so fourth quarter, that ramp-up, we're obviously aware that, that's an accelerated level compared to the first 3 quarters of the year.

Again, we've got the orders.

We've got the backlog.

Now it's execution on the plan.

And we're still -- we've -- [worked few out of] Series 80s.

We still have the class coming up onboard in Mexico, the Jabil one, which produces ATMs for us.

So we've got work to go.

Again, we feel pretty good that we can get there to that number.

We think it's attainable but not without a lot of work to get there.

In terms of the ongoing level of ATM, I think we exit the year, I guess, feeling pretty good about where we stand, and we'll talk more about our outlook for '19 when we get into the next call.

But there's a number of things.

Win 10, we talk about.

I think the competitive environment right now, we would view as a tailwind.

I think we feel pretty good about the product we have in the market and the success we're having with the hardware platform.

I think we feel pretty good about our software stack on the ATMs.

I think we feel pretty good about our service component on ATMs.

So I think we're feeling that going into next -- going into '19 that -- and then forward that we've got a little tailwind for the foreseeable future.

And we'll do some work coming out of fourth quarter and try to quantify that as we look at '19 and share that end of January, early February.

Second question just had to do with (inaudible) has been a narrative around (inaudible)

And Katy, I'm sorry, we can't hear you.

I don't know if you could pick up the handset.

Sorry, is that better?

Yes.

Okay.

Sorry.

One of the disconnects with the story has been this narrative around shifting to software and services relative to overall company margins that have come down.

And obviously, you walked through a lot of the headwinds that you're addressing, certainly lots of progress with M1 in services and the manufacturing and supply chain shifts in hardware.

So I just -- any high-level color?

Again, I know you're not providing 2019 guidance.

But are you confident that gross margins can begin to expand in 2019 and start to better mesh with the narrative around a shift to software and services, which should have higher margins?

Yes.

Katy, let me -- I'm actually going to split that question into 2 pieces.

So the gross margin, obviously, is more than just the software and service side.

A big piece of that's going to be the hardware and making sure we -- we incurred an awful lot of costs this year on transforming the manufacturing platform.

So that'll help.

As Andre kind of went through, had we converted the backlog at traditional rate, even that number in the third quarter would have been much better.

So gross margin, overall profitability, we need to have a focus on that and that we believe that in '19 we'll get some pickup from some of the things we've done in '18.

On the shift of software and services, I think that's going to be incremental.

It's going to be one step at a time.

I think that's going to take a few more cycles and a couple quarters.

The things that we're doing around reinvesting in our product, Owen talked about the ACAT, the Emerald product coming out, which is next-gen platform for retail.

Some of the other products we have on the retail side, hospitality and the banking side that we're investing in.

In addition to that, what we're doing with our M&A strategy, where we're going out and buying products like Zipscene -- or companies that have products like Zipscene and what we did with JetPay, where that will continue to shift the mix towards software or software-driven products and also the service platform.

But we're going to -- that's going to be a story that's going to be incremental quarter to quarter to quarter.

It's going to take us a period of time.

And what we want to do at this point, make progress each quarter towards that.

But I don't -- the results we had in '18 in terms of margin are just spreading across the board not just on the software, service side, but the strategic move towards software, towards services is going to take some time, going to take some investment, take some targeted M&A like you saw us do this quarter.

And our next question will come from Dan Kurnos of Benchmark Company.

Mike, maybe just on the sort of the POS landscape a little bit.

With the acquisition of JetPay, certainly, you guys are not the first to bundle point of sale and software.

And we're even starting to see some of -- in restaurant and a little bit to hospitality, some of the delivery or third-party guys leading with the tablets first, which I know is not your solution, more of a square solution.

But we're seeing massive consolidation in that space.

And I'm just wondering sort of with JetPay if it was more of a defensive, we need to do this to make sure that we can maintain our value in the chain or how you see sort of the landscape evolving with further consolidation and furthermore, if you are seeing any uptick on the checkout side with the phone versus an actual POS solution.

Yes.

I mean, I'll start with your first question in terms of the strategic importance or what triggered our action.

I would not characterize that as a defensive move.

I can tell you, when I started talking to the board and came on in late April, early May of this year, the conversations I had with our directors, conversations with -- I had with our management team literally day 1 is why aren't we taking advantage of initiating payments and processing the payment through the end of the merchant.

So we literally started in May looking for how we can monetize the transactions that we start not just with our POS but also with some of our gateway products that we have.

I do agree, the market's consolidating.

I think the merchant acquirers who are not as sticky as the people that own the enterprise software with the merchants, with the retailers, with the restaurants, probably have a more defensive imperative to go out and grab what we have on the front-end because it's really hard to move the POS enterprise software systems that we have in play.

It's much easier to shift the acquiring payments.

So I think we have a very good starting point.

We have, say, work to do to attach the back-end payment, but that's going to be part of the strategy going forward.

I think the new entrants and how they bundle, whether it's -- obviously, the -- and a lot of the industry benefits go brick and mortar.

They're shifting to try to participate in the digital side.

The fact that you can order with your mobile, pay with your mobile, we're going to -- we'll be participating in all those aspects.

I don't think the numbers yet are dramatic, but that's an important initiative for us to make sure that we can take the point-of-sale transaction, take the payment there.

We can take the payment on a mobile device when people order or when people pick up.

So we'll be following those trends as well.

And again, we feel pretty good about where we're positioned in that whole food chain of providing services to the retailers.

Got it.

And then you mentioned Zipscene in the prepared remarks, not a ton of quantitative or qualitative remarks around it.

Obviously, we've heard from prior management for, I don't know how long, that data monetization remains sort of a long-tail opportunity for you guys to go after with the understanding that you have a whole bunch of hurdles with maintaining client privacy, et cetera.

But can you just talk about sort of where you see that opportunity unfolding and how aggressive you expect to go after it?

Yes.

I think we feel pretty good about where we sit on that aspect as well the data that we have access to, the data we can gather from our, of course, point-of-sale systems and also our restaurant systems.

So there's different aspects around privacy.

So we're -- we just need to start, and we need to look at where we have opportunities to monetize the data that we have today.

The situation we have, so we'll say restaurant gathering, purchase data, purchase information around their client base, being able to take that information and doing analytics on it like the Zipscene product and then sell that back to that restaurant where we know we've got access to data, we've got permission to use data and we can create some value add.

So that's what we're starting with there.

We'll continue to look for areas where we can plug in, whether it's product, whether it's kind of infrastructure gathering data, and continue to monetize.

Again, I'll state the same.

This is not an overnight story.

I know we've talked about it.

We just have to make incremental steps where we can take advantage of the data, find a way to monetize it to our benefit.

And this is one small step forward for us.

Got it.

And last one for me just on the M&A front.

I know sort of strategic M&A continues to remain a focal point but if you can kind of just parse out your expected uses of cash, how big -- how aggressive you remain on the M&A front versus, obviously, with the shares trading where they are and understanding that you have some limitations on buyback -- continuing to buy back the stock.

Yes.

We -- I think we've been -- I'll take -- just in at least the last 6 months since I've been here that for us to be able to shift our company and shift the mix, we've got to use some of the capital to go out and do targeted M&A and do deals like we did with JetPay and Zipscene this quarter.

So our capital allocation, we'll talk about this next week at our Investor Day a little bit more.

But we'll buy back enough shares to take out the dilution in the marketplace, and we'll use cash flow to get a little bit of room on the balance sheet.

And then we'll try to do 4, 5, 6 deals a year, averaging about $100 million a transaction a deal and spend $400 million or $500 million on deals each fiscal year.

We're very cognizant of the price points, and I think last quarter, last board meeting -- a board meeting ago, we expanded our authorization.

So if we need to jump in -- I don't think our price has been driven down by our actions at this stage.

I think the whole market's moving a little bit.

But we'll keep monitoring, and I think we've got to be kind of focused for the long haul on how we can make steps to create more value in the long run.

I don't know, Andre, if you want to add to that.

Yes, Dan, I -- as I think about the free cash flow usage, so if you just take the midpoint of the $250 million to $300 million range that we gave you, so say, take $275 million.

We repurchased $210 million of stock already this year, so that's even twice amount of the dilution.

So $210 million.

We announced we'll spend about $184 million on JetPay, so that's about $119 million, $120 million use of free cash flow, so additional debt that we'll add this year.

So I think you saw in the charts we'll -- we ended the third quarter about 2.8x.

We generate a lot of that cash in the fourth quarter, so probably 2.7x at year-end.

And then if you add the pension in, which is not the in 2.7, you're probably up to 3.5x.

So that's about where we want to be.

And I think we had -- we held back on the additional share repurchase this quarter just given a number of factors, that JetPay was happening; we were announcing a restructuring; we had lower earnings, and obviously, we wanted to conserve cash.

So again, figure end the year, around 3.5x if you adjust for pension, and then we're willing to flex up a little bit more if we found the right acquisition.

And our next question will come from Paul Coster of JPMorgan.

I got a couple.

Mike, now that you've been in charge for a while, do you have some sense of what the secular outlook is for the ATM part of your business?

Do you consider it, as many investors do, a sort of slow decline?

Or do you actually believe there's growth opportunity here across the industry?

Yes.

I think it's kind of a time horizon.

So if you look at some date -- we look out into infinity so to speak.

If you look way out in the future, you can see a point where the ATMs and the use of cash is probably going to go down.

I think in the foreseeable future, as we look at the next 2, 3 years of planning -- and in our planning horizon, we kind of use 3 to 5 years.

We actually see some tailwinds the next 2 to 3 years.

We see, obviously, the Win 10 we've talked about.

We see the new product that we rolled out.

We see in the marketplace just the probably benefit of a little bit of market share pickup that we seem to be getting in 2018.

So we look at it from our perspective as is at least neutral, maybe a slight benefit the next 3 to 5 years in terms of the ATM footprint, not only the hardware but also the software stack and the service stack.

So if I look out 10 years, 15 years, clearly, our strategy is to continue to invest, continue to grow other parts of our business, the software and service component, higher recurring revenue streams, look at the margin on that side, but we don't think ATMs are going to hurt us over the next 3 to 5 years.

Okay.

And then, Mike, the investors are very intrigued by you and Frank coming to this company with your FinTech background and see you as potentially good proxies for going out and making acquisitions in the software, service space.

However, your multiple versus that of most software companies makes it very difficult for you to make acquisitions at a reasonable price for you.

Is your hypothesis, though, that in this kind of micro-cap private space, there's a lot of opportunities that are not going to be too expensive for NCR?

Yes, the price points that you pay in kind of the market, we go through cycles, are clearly at a high cycle of what's out in the marketplace, what kind of businesses you like to buy.

And we've kind of done this before.

We used to be part of the bank holding company.

We were a cash buyer.

We had to generate cash and try and give it back to the bank.

We had to be very focused on what we acquired.

So there'll be deals that take place in this marketplace today in 2018, 2019 that we simply can't compete, we can't write a check.

That being said, we don't need to buy customers and EBITDA streams in the marketplace.

We need to buy product.

We have an unbelievably strong distribution channel.

We have an unbelievably strong customer base.

So to the extent that we can go out and get products that we can distribute through our sales channels, to the extent that we can get product that we can cross sell and upsell to our customers, we think we can create that mix and shift to software to services.

We'll have to be -- there's no question we have to be diligent.

There's no question that the -- we're going to be buying at a -- we're a cash buyer.

We have limited room on the balance sheet.

But we still think we can do deals like we did this quarter going forward.

And we'll take the next question from Matt Summerville with D.A. Davidson.

Couple of questions.

First, can you provide a little incremental color on the retail, hospitality?

And sort of include self-checkout in there, those sides of the businesses.

And the degradation you're seeing in the top line, how much of that is, one, comparisons; two, NCR self-inflicted, we'll call it, execution versus what's actually happening in the market?

If you can dissect that, that would be helpful.

Yes.

I think it was probably a little bit of all of the above.

We obviously have a little bit of self-inflicted, we talked about it in the past.

Kind of mentioned some product cycles.

We talked about the ACATs going all the way back to -- we put those in place early second quarter.

And those were areas like SCO.

There's OPTIC devices which is a convenience gas station; Emerald, which is focused on retailers.

We didn't get the product to the market fast enough.

That clearly hurt us in '18.

Those products are up in pilot.

We're having success getting referenceable clients.

We'll get those out to our salespeople here in the fourth quarter, start building some momentum into next year.

So that clearly hurt us.

I think the market -- I think we feel pretty good about where we are positioned in the market, hospitality with the restaurant and Aloha products.

With the market share we have, we think it's a great opportunity to cross sell, upsell into that base.

Add and extend products around the core that we have, which is really the enterprise software that they run a restaurant with and then clearly, connect payments with JetPay, process a payment.

The retail space, the SCO 6 challenge was a big piece of that, getting the Emerald, which is the cloud-based retail product out there, starting to build some momentum, which we would hope to see starting in '19, be a part of that.

But we've got some work on our side.

I think the market opportunity, we still feel pretty good about heading into '19.

And then can you comment also -- just a question on the cloud portion of the business.

I don't have the numbers in front of me, but what I recollect off the top of my head, the amount of net ACV you had in Q3 was, I believe, the lowest number that NCR's reported in quite some time.

Can you talk about what you're seeing with Digital Insight?

What's going on there from a market share standpoint?

And then maybe comment more broadly on the Silver side of the business as well as maybe a little more on hospitality?

Well, yes, on cloud, it's really those 3 pieces.

It's Silver.

It's a wrap of products around Aloha.

So Aloha gets installed on the hospitality side of the restaurant, and then there's a series of products that wrap, that are cloud-based that can be reported as cloud.

And then obviously, Digital Insight.

I think every year you go into the cycle, you're going to have some puts and takes.

But you go on the banking side, where banks -- there's still a fair amount of consolidation taking place in the banks where we lose customers.

So we've always got to be bringing more clients onboard.

And we've gotten a little better, we did in second and obviously, third quarter, to sign new accounts.

But it really is across all 3 of those business lines.

And we brought in some new leadership on the Digital Insight side.

We brought in an experienced veteran in the industry for mobile and Internet banking.

And we're building up the team there to put some focus on that, and I think we'll see some success.

We're putting some focus on hospitality, put in a new leader to run hospitality this quarter as well.

So we've rebuilt the teams.

We've talked last quarter about realigning around business units or business unit focus.

We have somebody who takes ownership for going out and driving top line growth, for driving the investment and for driving -- adding new customers.

So I -- not where we want to be third quarter.

We've got a great deal of focus on that heading into fourth quarter, heading into 2019.

And our next question will come from Rob Wildhack of Autonomous Research.

Just want to start with the unattached license line flip to 15% growth this quarter.

What were the drivers of that?

And then what do you think is the kind of sustainable growth profile here going forward?

Yes.

So you always got to be a little careful.

The unattached license are -- we go out and sell a product.

Book a license fee sometimes goes up and down based on the timing.

So I don't -- I wouldn't get overly excited about the growth in any particular quarter because it might just be what happened last year and growing over.

We had great product growth in the banking side.

Past quarter, we've got a ton of product that does well.

We report those numbers.

I don't think -- again, our management focus is just consistency and selling long-term contracts and value.

So that's more of a up and down.

And when they go down, our answer is going to be the same quite frankly.

Yes.

This is Andre.

We sold some bundles with the increased third-party content, so that's got a higher cost to us and a lower overall margin.

But then again, that drove revenue higher in the quarter.

Okay.

And then the cash flow guidance is down this year.

I understand that.

With all the longer-term strategy shifts, restructuring programs, et cetera, I mean, is there any change in your view to the long-term cash generation profile of the business?

No.

I mean, we -- the conversion rate that we would expect to see going forward are still going to be in that 80%, 90% that we've seen historically.

I think we were -- we were doing (inaudible) generating cash actually last couple of years.

This year, we clearly got hit by just the shift we -- we've got elevated inventory levels on raw materials on finished goods that are going to hit us in fourth quarter, which is why we brought that down.

We're going to have some cash spend related to -- from the cost efficiency actions we're taking in the fourth quarter.

But I think long term, you should look at it, say, the extent that we're generating earnings that should convert to cash flow.

And that does conclude the question-and-answer session.

At this time, I'll turn the conference back over to Mr. Mike Hayford for any additional or closing remarks.

Let me start by thanking everyone for joining us today on our third quarter earnings call.

To close, I want to make a couple points.

First, we've made some great progress addressing our execution challenges and positioning NCR to return to growth.

However, we do recognize there is more work to be done.

Secondly, acquisitions of JetPay and Zipscene are exciting opportunities for NCR.

They are indicative of our targeted M&A strategy to acquire solutions that we can leverage with our existing product portfolio, our existing sales distribution and drive software and services revenue.

And lastly, I feel confident that we will be getting back on track and positioned for growth heading into 2019.

Again, I want to thank you for your time today.

I, along with the rest of the NCR team, look forward to providing with some more detail on our updates on our strategy, our operations and our progress during our Investor Day next Wednesday on November 7.

And that does conclude today's teleconference.

Thank you all for your participation.

You may now disconnect.