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Edited Transcript of NCR.N earnings conference call or presentation 27-Oct-20 8:30pm GMT

·51 min read

Q3 2020 NCR Corp Earnings Call DULUTH Oct 28, 2020 (Thomson StreetEvents) -- Edited Transcript of NCR Corp earnings conference call or presentation Tuesday, October 27, 2020 at 8:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Michael Dale Hayford NCR Corporation - President, CEO & Director * Michael Gary Nelson NCR Corporation - VP of IR * Owen J. Sullivan NCR Corporation - COO * Timothy C. Oliver NCR Corporation - Executive VP & CFO ================================================================================ Conference Call Participants ================================================================================ * Charles Joseph Nabhan Wells Fargo Securities, LLC, Research Division - Associate Analyst * Daniel Louis Kurnos The Benchmark Company, LLC, Research Division - MD & Senior Equity Analyst * Ian Alton Zaffino Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst * Joel Hoeffler Stephens Inc., Research Division - Senior Associate * Kathryn Lynn Huberty Morgan Stanley, Research Division - MD and Research Analyst * Matt J. Summerville D.A. Davidson & Co., Research Division - MD & Senior Analyst * Matthew Van Roswell RBC Capital Markets, Research Division - Assistant VP * Paul Chung JPMorgan Chase & Co, Research Division - VP & IT Hardware Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good day, ladies and gentlemen, and welcome to today's NCR Corporation Third Quarter Fiscal Year 2020 Earnings Call. A quick reminder that today's conference is being recorded. And at this time, I'd like to turn the floor over to Mr. Michael Nelson, the Vice President of Investor Relations. Please go ahead, sir. -------------------------------------------------------------------------------- Michael Gary Nelson, NCR Corporation - VP of IR [2] -------------------------------------------------------------------------------- Good afternoon, and thank you for joining our third quarter earnings call. Joining me on the call today are Mike Hayford, President and CEO. Owen Sullivan, COO; and Tim Oliver, CFO. Before we get started, let me remind you that our presentation and discussions 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'll also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts in the presentation materials, the press release dated October 27, 2020, 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. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [3] -------------------------------------------------------------------------------- Thanks, Michael, and thank you, everyone, for joining us today. I will begin with an overview of our third quarter performance and an update on our progress executing against our strategic initiatives. Before turning it over to Tim, who will review our third quarter financial numbers. Then Owen, Tim and I will take your questions. I'll begin on Slide 4 with the highlights from the third quarter. NCR delivered solid performance despite the current business and operating challenges that continue to be impacted by COVID-19. Our teams have continued to show resiliency in these unprecedented times and continue focus on taking care of our customers. On our last call, I noted that NCR would start shifting management attention from the pandemic and instead get more focused on growing our business during the second half of 2020 versus the first half of the year. In the third quarter, we have successfully taken steps down that path. First, one of the primary highlights of the third quarter was our strong free cash flow generation. We delivered $150 million of free cash flow in the quarter and $299 million of free cash flow through the first 3 quarters of the year. Tim will discuss in more detail the drivers of our strong free cash flow production. Second, we expanded EBITDA margin to 15.7% in the third quarter, which represents an increase of 220 basis points from the second quarter and an increase of 10 basis points from the third quarter of 2019. As we discussed on our second quarter earnings call, when the pandemic began, we focused on reducing cash costs. In the third quarter, we began to execute the productivity improvement initiatives that were temporarily sidelined by the pandemic. These initiatives are focused on reducing recurring costs to drive margin expansion, and our performance in the third quarter is the result of some of these early actions we have taken. Third, we delivered 7% recurring revenue growth in the third quarter. This marked our third consecutive quarter delivering that level of year-over-year growth, which speaks to the steady progress we are making, generating increased recurring revenue which is consistent with our 80/60/20 goals. Fourth, we began taking steps to reduce our leverage and simplify our capital structure while also maintaining a strong liquidity position. Tim will speak to this in his remarks. And finally, while we don't expect a near-term end to the COVID-19 pandemic, we are adjusting to this new environment for both our customers and our NCR team. We continue to expect impacts to our business with hybrid sales to be the most challenged. Now moving to Slide 5. We have forged ahead executing our strategy despite unprecedented market disruption. We have added new customers, deepened our relationship with existing customers and continued to invest in our strategic growth products like digital banking, Aloha Cloud, Emerald, our retail cloud POS, and payments. We will continue to focus on our transformation to drive NCR as-a-Service and achieve our 80/60/20 strategic goals. In the third quarter, software and services were 71% of our total revenues, and 53% of our revenues were recurring. EBITDA margin was 15.7%. In banking, we continue to have positive momentum in our digital banking platform, with 6 new customers signed in the third quarter. We've also had success cross-selling existing clients with new products, including 12 business banking deals done in the quarter. Also in the quarter, our digital banking registered users increased 12% to more than $24 million on a year-over-year basis. We are also having increased success shifting our banking software revenue to recurring revenues. Both software historically attached to an ATM sale as well as software unrelated to an ATM sale. In the third quarter, we signed nearly 250 banking deals to a recurring revenue model that previously would have been sold as an upfront software license. One example of the top 5 U.S. bank that recently agreed to a multiyear recurring software agreement to move to our activate enterprise next-gen platform to modernize their software stack that serves a multi-vendor ATM environment. In retail, we are seeing increased adoption of our self-checkout solutions. We experienced demand across customers and geographies as consumer preferences accelerate. We continue to be excited about the sales funnel of our Emerald offering, which is our next-gen cloud-based retail point-of-sale solution. In hospitality, the momentum of Aloha Essentials, which bundle software, services, hardware and payments continued in the third quarter. This model is proving itself in our ability to track new customers as well as better service existing customers. During the third quarter, roughly 80% of all SMB Aloha sites sold through our direct offices that were sold as a subscription bundle, with payments attach rate also strong at roughly 80% for sales into new sites. As we drive the transformation of our business, we will strive to be even more efficient and effective steward of our resources. We continue to focus on taking care of our customers, advancing our product capabilities with investments in our strategic growth platforms and continuing to strive to improve our productivity. With that, let me pass the call over to Tim. -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [4] -------------------------------------------------------------------------------- Thank you, Mike, and thanks to all of you on the phone for tuning in today. As has been our practice, my comments will again presume a constant currency adjustment that removes the impact of foreign exchange. Though this quarter, currency had only a minor impact. Starting then on Slide 6, which presents a top level overview of our third quarter financial performance. As you can see, we added a rolling 5-quarter view to these metrics. While they typically focus on year-over-year comparisons, the significant disruption to economic activity caused by the pandemic may overwhelm typical seasonality and make sequential comparisons illustrative, at least for the next couple of quarters. Starting on the top left, consolidated revenue was $1.59 billion, down $194 million or 11% versus the 2019 third quarter. As expected, revenue was negatively impacted by the broader economic cost but the year-over-year decline did improve from the second quarter. And in fact, revenue was up 7% versus our second quarter results. We will dig into the more specific drivers of the decline by business unit, but in aggregate, $165 million or 85% of that decline is attributable to lower hardware revenue, which was down 26%. As Mike described in his remarks, our continued effort to shift to recurring revenue streams, again, accelerated sequentially. We shipped $27 million or over 1.5 points of revenue that previously would have been booked upfront as a perpetual sale to a recurring revenue stream. This compares to just $11 million in last year's third quarter or $22 million in this year's second quarter. Sequentially, all of our business units showed growth, and impressively, revenue in our retail business was actually up year-over-year. On the top right, adjusted EBITDA decreased $29 million or 10% year-over-year to $249 million, in line with the revenue decline. And we were able to expand EBITDA margin rate by 10 basis points to 15.7%. Sequentially, adjusted EBITDA grew 24% and EBITDA margin rate extended by 220 basis points. This expansion was a result of cost reductions we initiated during the second quarter, but that reached their full impact in Q3. As Mike mentioned, we have now begun to drive significant productivity improvement initiatives across the entire organization that were planned for the spring, but were delayed by the pandemic. And while actions taken in Q2 like salary reductions and discretionary spending constraints were immediate and significant, they have a more temporary nature. Our ongoing productivity efforts are more permanent and of larger magnitude, which will assure sustainable margin expansion even at pandemic levels of revenue. Similar to the discussion of revenue, the shift to recurring revenue as an important descriptor of our relative EBITDA results. $21 million of adjusted EBITDA did shift out of the quarter, accompanying the respective revenue shift. This compares to $7 million in the year ago Q3 and $18 million sequentially from Q2. In the bottom left, non-GAAP EPS was $0.54, down $0.19 from the prior year third quarter and double the $0.27 we posted in Q2. The tax rate of 15% for Q3 declined due to lower annual income and the relative size and timing of discrete tax benefits within the year. And finally, and maybe most importantly, we delivered an exceptionally strong $150 million of free cash flow versus $57 million in the year ago quarter. This increase is due primarily to an increased focus on working capital improvements, particularly on past due receivables, on cash cycle linearity and on raw and finished good inventory. Year-to-date, our free cash flow generation is $299 million versus a use of cash of $27 million through the first 3 quarters of last year. Moving to Slide 7, which describes our banking segment results. Banking revenue decreased $165 million or 17%, mainly driven by a 40% decline in ATM hardware sales. While hardware sales remained soft due to the banks' pandemic spending constraints, remember that we also are comparing to a very extraordinary quarter in last year's third quarter where ATM sales were up 60%. On an absolute basis, ATM hardware sales seem to have settled into a relatively consistent range of $200 million to $250 million per quarter, and we anticipate this range will persist at least for the next couple of quarters. Most of the remaining decline in banking revenue can be attributed to the service revenue associated with the foregone installation of those new machines and the continued expansion of our recurring revenue model. Excluding the decline in new ATM hardware and the directly related revenues, our remaining banking businesses would have shown modest growth year-over-year. Operating income decreased $47 million or 32%, and operating margin rate dropped by 280 basis points to 12.7%. These declines were driven by lower revenue and the resulting unabsorbed costs partially offset by lower discretionary spending and other caution issues put in place earlier in the year. Operating expenses were down 4%. On a sequential basis, revenue was up 2% and operating margin expanded by 60 basis points. Moving to Slide 8, which shows our retail segment results. Retail revenue increased $17 million or 2%. Last quarter, we discussed the delay for installing self-checkout units at several of our larger customers as many of these customers were too busy operating their stores during the pandemic to undertake an installation project. As anticipated, these orders were delayed and not canceled. In the third quarter, we delivered some of those orders. As a result, self-checkout revenue experienced strong double-digit growth. In concert with revenue, operating income was up $9 million or 25%. The increase was driven by higher revenue as well as by discretionary spending and cost initiatives taken earlier this year. Operating expenses were down 7%. On a sequential basis, revenue was up 15% and operating margin expanded by 460 basis points. Turning to Slide 9. Slide 9 shows our hospitality segment results. Hospitality revenue decreased $43 million or 20% driven primarily by lower hardware sales. As expected, our hospitality segment has been the most impacted by the coronavirus, with capacity limitations and changes to our customers' behaviors. Third quarter operating income declined $3 million mainly due to the flow-through impact from lower revenue. While we were able to reduce operating expenses by 17% with our cost initiatives, prudently higher reserves on accounts receivable offset some of those savings. On a sequential basis, revenue was up 8% and operating margin expanded by 400 basis points. Turning to Slide 10. We provide our third quarter revenue results under our previous operating segments for both continuity and color. Software revenue decreased $44 million or 9% due to the shift from onetime to recurring revenue. Lower sales attached to new hardware and challenging conditions for our hospitality business. Services revenue increased $15 million or 3%, driven by an increase in recurring services revenue, including hardware maintenance, managed services and digital connected services revenues, all partially offset by lower installation revenues. And finally, as I mentioned previously, hardware revenue was most impacted in the quarter by the pandemic, declining $165 million or 26%. ATM revenue declined 40%, while the combination of self-checkout and point-of-sale declined 7%. Software and services as a percentage of total company revenue increased to 71% from 65% in Q3 of 2019, admittedly, in large part due to lower hardware sales. Recurring revenues increased $50 million or 7%, driven by a programmatic effort to shift our sales away from single sales events characterized by perpetual licensing and uncertain service revenues to predictable multiyear commitments with relatively high certainty of revenue generation. This quarter's improvement came from shifting our professional services contracts to provide more stand-ready services, shifting our software licenses to term licenses that include appropriate termination clauses and providing more services in the cloud. Recurring revenue as a percentage of total company revenue increased to 53% from 45%, also benefiting from lower hardware sales. On Slide 11, we present free cash flow, net debt and adjusted EBITDA metrics. As I mentioned earlier, we are very pleased with our performance on the cash side. Free cash flow was $150 million for the quarter, which was a significant improvement from the $57 million in the prior year. Year-to-date free cash flow of $299 million, up from a use of $21 million in the prior year. Our efforts to improve working capital and drive more linearity in our annual cash flow generation are working well. This slide also shows our net debt to adjusted EBITDA metric, with a net debt leverage ratio of 3.1x, which is consistent with last quarter and with the prior year. As you know, at the end of March, we drew down over $600 million on our revolver. And at the beginning of April, we issued a $400 million bond as a precautionary measure to derisk our balance sheet and ensure financial flexibility in uncertain times. The cumulative effect of all those actions was a very solid balance sheet with sufficient liquidity and no significant near-term debt maturities. We ended the third quarter with $1.6 billion of cash, having already reduced our term note debt by $200 million. Since that time, we have executed a couple of other transactions to delever, which I'll update on the next slide. We remain well within our debt covenants and ended the third quarter with credit facility leverage of approximately 3.3x, well under our debt covenant maximum of 4.75x. And my last slide is Slide 12, which provides a description of the 3 different but related redeployments of excess cash to reduce leverage and describes the impact of those transactions. As we discussed last quarter, as we become less uncertain about the economic environment and become more certain about our ability to operate effectively at these pandemic impacted levels of demand, we have begun to reduce some of the precautionary leverage that we added back in the spring. First, we addressed an approaching debt maturity stack in 2022 and '23 and took advantage of a favorable credit market environment. In August, we closed 2 new bond offerings for $650 million at 5% and $450 million at 5.25%, with maturities of 8 and 10 years, respectively. We used these proceeds, augmented by $200 million of existing cash to redeem our prior $600 million 5% senior notes and $700 million 6.375% senior notes. These transactions extended our weighted average debt maturities, eliminated near-term refinancing risk and lowered our interest expense. These new debt offerings will result in lower annual interest expense of approximately $19 million, and as a result, are expected to be accretive to EPS in both 2020 and in 2021. Second, at the beginning of the fourth quarter, we purchased and retired 132,000 shares of the outstanding Series A convertible preferred stock, which represented about 32% of NCR's outstanding convertible preferred stock. This transaction will reduce our annual dividend burden by more than $7 million and it's expected to be net accretive due to the $4.4 million share reduction in our diluted share count on an annual basis. And third, based on the strong free cash flow performance year-to-date and our confidence in the outlook for our business, early in the fourth quarter, we paid down $470 million of our revolver. This will further reduce our interest expense by $8 million. In total, since the beginning of the third quarter, we have redeployed a net $800 million in capital transactions for an annual savings of $34 million through lower interest and dividends. And with that, I'll turn it back to Mike for his closing comments. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [5] -------------------------------------------------------------------------------- Thanks, Tim. In closing, our key priorities moving forward are clear. First, we will continue to further execute on our NCR-as-a-service and 80/60/20 strategy. We have made notable progress this year despite some of the challenging conditions. Second, our financial position is sound. We have ample liquidity and financial flexibility while also investing in our innovative solutions. We will continue to allocate capital in our strategic growth platforms such as digital banking, Emerald, next-generation Aloha, payments and digital connected services. We will also consider acquisitions and paying down debt. Third, we will continue to focus on driving significant free cash flow generation, which go hand-in-hand with advancing our strategy. Fourth, we are building momentum across the business for improved execution and performance in 2021. And lastly, I'd like to extend an invitation to each of you to participate in our virtual Investor Day, which is scheduled for December 3. We are looking forward to an event and intend to take a deep dive into our strategy and path forward in achieving our 80/60/20 goals. Thank you for your time today. And with that, we will open up the call for your questions. Operator? ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) And first, from RBC Capital Markets, we have Dan Perlin. -------------------------------------------------------------------------------- Matthew Van Roswell, RBC Capital Markets, Research Division - Assistant VP [2] -------------------------------------------------------------------------------- Yes. It's actually Matt Roswell filling in for Dan. A couple of quick questions. First of all, on the margins and the cost reduction efforts, how much of what you had planned to do earlier in the year before the pandemic hit do you think you've accomplished and sort of how much is left? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [3] -------------------------------------------------------------------------------- Yes. So we, originally announced beginning of the year that we would do about $90 million of cost takeout in 2020. And as you would recall, when the pandemic hit, we put that at hold. We didn't think it was appropriate during that very difficult time to be letting our employees go. So we deferred any actions other than kind of a cost take-out that we could do. We took down some salaries of some of the executives. Discretionary spend we reduced and so some of those savings flowed into third quarter. On the second quarter call, we talked about getting back to focus on executing our business. In second half of the year, I think we called it 20, 20.5. And we said as part of that, we're going to get our cost structure aligned with our business. So we did some of those actions in the third quarter. We have plans to continue to do some into the fourth quarter. We will certainly reach that $90 million by the end of the year. So meaning, we'll have a $90 million run rate as we head into 2021. -------------------------------------------------------------------------------- Matthew Van Roswell, RBC Capital Markets, Research Division - Assistant VP [4] -------------------------------------------------------------------------------- Okay. Switching to the banking business. With hardware, I think with the ATM business sort of been about $200 million to $250 million a quarter, I think is what you said. Given the growth in digital and the other products, when do you sort of see kind of a crossover point, meaning ATM business is kind of flattish, but then you actually see growth because of the other pieces? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [5] -------------------------------------------------------------------------------- Yes. Obviously, we had a strong ATM year last. This year, we've seen the bank be a little more cautious on some of their spending -- on discretionary spending, particularly on the -- on the software side, they continue to make investments in digital banking and some of the other software products as well as some of the professional services that we deliver with the software during 2020. I don't know that we have a specific time frame. As we've talked the last couple of years, our ATM business is still an important part of our strategy. But we have shifted the focus to the digital side, digital banking, digital-first on our software product. And those continue to have pretty good strength here in 2020 versus ATMs, which have slowed down to a fair degree. I don't know, Tim, if you want to add to... -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [6] -------------------------------------------------------------------------------- Yes. We've been running for the last several quarters at about $220 million a quarter on ATMs and it's been relatively consistent for the last 3, I would expect for the next couple, that will remain true as well. I don't know at what point in time banks will loosen up their capital spending. We would hope that there'd be a little pickup when that happens. But we ought to have easier comparisons in Q1 next year and be relatively flattish from an ATM perspective, which allow the rest of our banking business to demonstrate its growth. I'd also like to say that in this quarter, for the first one in a while, non-ATM hardware was higher in terms of revenue than ATM hardware was. -------------------------------------------------------------------------------- Matthew Van Roswell, RBC Capital Markets, Research Division - Assistant VP [7] -------------------------------------------------------------------------------- Okay. One more question if you let me. Switching over to hospitality. Looks like Aloha has seen great demand. Are you seeing an acceleration in the shift to sort of the services model? You mentioned the central bundle? I mean is that pandemic-driven? Is that you all doing it? Or is that just -- it's time, and it's happening. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [8] -------------------------------------------------------------------------------- Well, I'd say it's primarily our focus to shift that business to be able to run the restaurant. And so bundling up the software, bundling up the hardware, bundling up the services to install and support and then bundling up the payments. That's been the shift of our business focus. And that's why those numbers we talked about, 80% of our uptick is on a bundle. And the attach on payments have been very strong in the SMB market as well. I think it's playing well in a COVID market where people in that segment of the market needs help getting up and running, and they want simplicity, they want a single vendor who can come and deliver a full turnkey to run their restaurants. So I think that's part of it. But I think the primary driver is the shift in our business model. -------------------------------------------------------------------------------- Operator [9] -------------------------------------------------------------------------------- Moving on our next question from Stephens, we have Brett Huff. -------------------------------------------------------------------------------- Joel Hoeffler, Stephens Inc., Research Division - Senior Associate [10] -------------------------------------------------------------------------------- This is Joel on for Brett. So just on digital banking, could you talk about maybe the competitive environment? You guys seem to be more competitive. And any color that you could provide on that would be extremely helpful. And then just as a follow-up to that. Any color around penetration or adoption rates among your bank clients using digital banking? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [11] -------------------------------------------------------------------------------- Well, I mean, I'll start with the competitiveness. We talked about this last year. We talked about this, this year. So last year, our team there, led by Doug Brown, did a phenomenal job, fairly changing and particularly to the digital insight in terms of focus on customers and retention and then being able to start adding accounts. So as we get into 2020, they continue to do that. I mean we compete with everybody out there. We certainly believe we're winning competitively. Time to time, we're probably going to lose 1 or 2, a handful here and there. But we feel really good that we're net adding in '19 that we will net add in 2020 in terms of the marketplace. And so I think that competitive aspect is exactly what 1,000 (inaudible). Our D3 product is doing really well as well. So we feel pretty good about digital banking as we move forward. The pickup rate and the adoption, I think we referenced the numbers, and I'll let Owen speak to it, but that's what customers talk about is the shift to the install. Owen, do you want to add some color there? -------------------------------------------------------------------------------- Owen J. Sullivan, NCR Corporation - COO [12] -------------------------------------------------------------------------------- Yes. I think consistent with what both Tim and Mike talked about, what we are clearly seeing is a step-up in investment from the banks on their digital platforms. We're seeing it both with the digital insight and D3 product. We're seeing with the rest of the banking platform that we have in the market. And it's coming across in license. It's coming across in the professional services space. And I believe we have talked about the step-up, although we haven't disclosed the growth. That's not something we've put out there yet in terms of end market growth rates. But we clearly are seeing, and this is COVID-enhanced, a pickup in our customers and consumer activity on the digital platform. -------------------------------------------------------------------------------- Operator [13] -------------------------------------------------------------------------------- Our next question comes from Dan Kurnos, with the Benchmark Company. -------------------------------------------------------------------------------- Daniel Louis Kurnos, The Benchmark Company, LLC, Research Division - MD & Senior Equity Analyst [14] -------------------------------------------------------------------------------- Great. Maybe, Mike, if you could just give us some geographic color on what you're seeing would just be helpful. And I'll give it to you if you want to break it down by segment or not. And then just as we think about sort of the COVID-driven evolution of the entire landscape. I know that you guys have done a great job with free cash right now, which probably gives you some of the ammo you want to go back to doing some of your tuck-ins. But how do you view that on the tech side versus maybe partnership opportunities that could get you deeper penetrated into some of the verticals that we're seeing develop here? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [15] -------------------------------------------------------------------------------- Yes. Let me -- I'll start the last one in terms of -- so the COVID impact and where we see that. We've talked at each quarterly call and obviously, back in March and April, when this thing first hit, it was kind of hard to see the depth or the duration quickened the pandemic to health issue. But nonetheless, we had to make some assumptions. And I think we always said second quarter was going to be difficult. We said third quarter is going to be similar on a year-over-year. We did a little better in the third quarter than second quarter, if you look at year-over-year comparisons. I think we were a 12% constant currency in the second quarter, a little bit in the third quarter. I think now we would look at it and say, we don't see the health care resolve yet. And so it's probably going to bleed a little bit into '21. Certainly, we don't think it's going to be over within the first quarter. So when do we start to see, when we say, oh, when do we get normality once the people go back to restaurants, when they can go to stores and operate normal. So we think that's pushed into next year. We did, as you pointed out, Dan, put a lot of focus the whole year on cash flow. We had very successful cash flow in the third quarter based on managing our costs, even with lower revenue and managing our cash flow itself. Year-to-date, we're actually not only ahead of where we were last or year-to-date. But I think as Tim referenced, we're at a higher number right now than we were for the full year last year. So we feel really good about the cash flow. That gives us the opportunity -- we took some of our debt off the table. We bought back some of our preferred stack, which is an expensive private capital structure. And then we announced in the second quarter call that we would start looking at opportunities to do tuck-ins, which we will do -- tuck-in acquisitions or other acquisitions that will help us grow and aggressively move forward. So we will continue to do that going forward. I don't -- and maybe, Tim, you just want to comment just on how we kind of view 2020 into 2021 from a numbers perspective. -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [16] -------------------------------------------------------------------------------- Yes. I think the -- we're likely to see that this quarter play out again, meaning the third quarter. The fourth quarter is -- will look a lot like the third quarter. From a revenue perspective, there's no reason to think that the markets that our customers sell into are going to get any better. And I would expect similar demand for us in Q4 that we saw in Q3 and actually in the same place as I expect the mix to be relatively similar as well. I also expect it will hit a margin rate that's similar to the one we just achieved in this quarter. As you said, the cost actions we took in Q2 were relatively temporary and immediate. We're making a shift to much more permanent productivity initiatives that will drive future period profitability and make that a more sustainable improvement to margin rate. And I think on the cash flow side, Mike, as you said, we're getting much more linear in the way we conduct our business from the top down from revenue on down through. It's made a huge difference on cash flow. And the performance you saw in Q3 was outsized to our typical Q3 performance. And then Q4 will be -- that will be good. We may have borrowed forward a little bit of the typically very strong Q4 cash flow into Q3. But it'll still be -- it will positive and demonstrably so. -------------------------------------------------------------------------------- Daniel Louis Kurnos, The Benchmark Company, LLC, Research Division - MD & Senior Equity Analyst [17] -------------------------------------------------------------------------------- And then just maybe, Mike, obviously, there -- on the ATM is understandable. I know that nobody is really spending right now, but I'm just wondering how the conversations are going around ITM and kind of future branch closures. Are you trying to get stuff on paper now? Or are you thinking about -- how are you thinking about that in conjunction with, obviously, the strength you're seeing in digital? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [18] -------------------------------------------------------------------------------- Right. Yes, I would say that the conversations that we are having across the markets. And it would be the European market, Middle East, Australia. Here in the U.S., the banking community is focused on the self-service bank platform. As I mentioned before, we're seeing it in the investment we're making in the software, the digital platform. And what we are seeing is a clear pause in the use of capital, and that has impacted the ATM activity. To Tim's comment, we are -- we have been seeing the $220 million to $250 million range on ATMs, and we think that's probably a fair number as we move forward. And we think the market will roll from an ATM perspective as we've talked about it for a while, which is relatively flat over the next several years. But the ATM, ITM is still a key part of the strategy going forward. We just think there's a little bit of preservation of capital going on right now with our bank customers. So we're not hearing anyone run from the ATM or ITM or touting that money is going away or the need to deploy the ATM ITM as part of a distribution strategy has shifted. -------------------------------------------------------------------------------- Operator [19] -------------------------------------------------------------------------------- Moving on, we have Matt Summerville with D.A. Davidson. -------------------------------------------------------------------------------- Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [20] -------------------------------------------------------------------------------- Just a couple of questions. First, Owen, I want to make sure I heard you correctly. You're not anticipating a sort of normal seasonal sequential uptick in revenue for any of the businesses in Q4 relative to Q3? -------------------------------------------------------------------------------- Owen J. Sullivan, NCR Corporation - COO [21] -------------------------------------------------------------------------------- No, we're not. And I think there's a couple of things. Clearly, the market dynamic that we're seeing, which is more of a contemplated spend on ATM is clearly what we're hearing from our bank customers. The other thing which both Tim and Mike touched on is a little bit of a cultural shift that we're trying to instill here in the company, which is to create more of a predictable quarter-to-quarter level of performance from a revenue standpoint, from an EBITDA performance standpoint and from a free cash flow perspective. So we have tried to instill, let's not keep pulling things artificially left. You'll see it even in the way that we have moved our software to -- from perpetual to subscription, which has clearly changed behavior at the end of the quarter and certainly at end of year of our salespeople out there trying to get that last big deal in the door, which creates pricing erosion when you do that because we're playing with the customer's time line. So we've consciously tried to make an effort to smooth out our performance quarter-to-quarter, which we think allows us to be a better performing business. And I think that the fact that right now the ATM market is behaving the way it is, just -- is more coincidental than anything else. -------------------------------------------------------------------------------- Matt J. Summerville, D.A. Davidson & Co., Research Division - MD & Senior Analyst [22] -------------------------------------------------------------------------------- Got it. And then maybe if you guys can spend a couple of minutes or a couple of seconds, just talking a little bit about what came in the self-checkout environment. If demand there remains strong, incoming orders, backlog. And if you think that strength has multiyear sort of legs underneath it, given the shift towards more friction-light transactions. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [23] -------------------------------------------------------------------------------- Yes. I mean we -- self-checkout or being able to manage your own interaction with effectively self-pick at a store had been making a shift, and we've been seeing that solid. The pandemic crisis, obviously, we think, accelerated that. And we'll continue to push that forward. So the ability to lock into a store and do your own self-pick and self-checkout without having a person touch your items. And as we talked on the last quarterly call, we actually have helped a number of our very large clients activate pay from phone, pay from the app on your phone so you don't even have to touch self-checkout device when you do the scanning. So we think that, that business is solid. We think that this will give us some strength going forward. And we certainly saw that in the third quarter. Tim, do you want to speak to the numbers? -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [24] -------------------------------------------------------------------------------- Yes. Well, so self-checkout accounted for more than all of the growth in the retail business, and the retail business was up year-over-year. So I'd say, a bright spot in our quarter. And yes, the -- looking forward, the order book is strong. -------------------------------------------------------------------------------- Operator [25] -------------------------------------------------------------------------------- Coming from JPMorgan, we have Paul Chung. -------------------------------------------------------------------------------- Paul Chung, JPMorgan Chase & Co, Research Division - VP & IT Hardware Analyst [26] -------------------------------------------------------------------------------- So just a follow-up on self-checkout. Can you kind of walk us through the unit economics of sales. So the ASP of the solution for a hardware standpoint and then the relevant operating margins. And then the services and software kind of offering over time and then the life cycle. So for example, the Watson Group announcement based on number of stores, can we get to a number of free cash flow number from this deal over time? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [27] -------------------------------------------------------------------------------- Yes. I mean, I'll just generically -- every deal is maybe a little differently, depending on where they're at, on whether it's just a pure hardware deal. Obviously, when we sell self-checkout, there's a piece of software that goes with it. Some clients are moving forward with a little bit more comprehensive POS software upgrade, potentially, or the ability to be able to manage the assisted lane and self-checkout lane there. As I referenced before, as we sat into the pandemic, the ability to do more frictionless and to do a pick and a checkout and then a pay off your own mobile device. Our professional services team has had a lot of activity supporting and helping clients, not only third quarter but also second quarter. So I don't know if I can really in a position to kind of break out, as you said, what is the average selling price and what gets dragged along. Because I don't -- I think self-checkout is even more unique. It's each individual sale versus maybe what we can see in the ATM market. -------------------------------------------------------------------------------- Paul Chung, JPMorgan Chase & Co, Research Division - VP & IT Hardware Analyst [28] -------------------------------------------------------------------------------- And then nice momentum on D3 with First Horizon. Can you give us a sense of how to size up this win as well? And then how quickly can you deploy the solution? And what's the timing of revenues and earnings potential over time? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [29] -------------------------------------------------------------------------------- First Horizon was actually -- they are already a D3 client. So what we announced in the press release is they actually took and reported. They were running that on-prem, in-house reported that. We're now managing. We're managing in the cloud, we -- with AWS Cloud instance. We're seeing most of the D3 clients wanting to move to the cloud. It gives the flexibility to really scale up rapidly. We need to peak. That's one of the huge advantages of that, right? And we're seeing most people -- I shouldn't say most, we're seeing clients like that, that we want to you, NCR, to help run that for us. The First Horizon also had paid down a large acquisition. So we brought on that additional volume onto the D3 platform and then they added some other feature functions. So the First Horizon deal is a nice deal, it's really an expansion and a shift of the relationship that we've had for a number of years. -------------------------------------------------------------------------------- Operator [30] -------------------------------------------------------------------------------- And our next question comes from Katie Huberty with Morgan Stanley. -------------------------------------------------------------------------------- Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [31] -------------------------------------------------------------------------------- Tim, I just want to revisit your comment about the December quarter. When you talk about similar demand, does that mean you're thinking about a year-on-year decline in the 13% range that you've seen in the last couple of quarters? Or does that mean that, that revenue is flat sequentially? -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [32] -------------------------------------------------------------------------------- Yes. So I think revenue will be up modestly sequentially. So the number you just described is probably about right. Look, there's a lot left to go in the quarter, and any one deal can swing that 1% or 2%, right? So -- but I do think that as we sit here today, the demand particularly in the things that we can measure easily like hardware looks to be very similar to what demand was in Q3. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [33] -------------------------------------------------------------------------------- I mean in the prior question around a big end of quarter, end of year spike in the hardware business. I think all we're saying is, we don't necessarily see that occurring this year. Part of that is due to the shift in our business model and trying to smooth those out and part of it, quite frankly, is due to COVID. And probably more so the bank. It's really a tail to have the banks sitting there saying, let's see what happens with the marketplace and economy before we start spending money on the ATM. So while we think that will effect the fall out, we're not sure that's going to hit in the fourth quarter here. And then on the self-checkout, you have the normal end of year. They're too busy executing. And this year, in particular, too busy running their stores to really be hopping a bunch of new scores on the floor. So again, we think it's going to be slightly sequential left from third quarter, but maybe not the big prop we've seen in prior fourth quarters. -------------------------------------------------------------------------------- Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [34] -------------------------------------------------------------------------------- And as we think about EBITDA margins into next year, just from a high level. Obviously, the weaker mix of hardware is helping this year. As hardware starts to recover in 2021, do you think you can take out cost fast enough that you will be able to offset that and you can continue to expand EBITDA margins in the medium term? -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [35] -------------------------------------------------------------------------------- Yes. Yes. Yes, absolutely. So the cost takeout that we're working on currently I would say, is more indirect or associated with our services and software businesses and not necessarily with our production or manufacturing footprint. That's being planned now. And you can imagine we're going to size our capacity to a level of output on both ATMs and SCO that is more like what we're seeing now. So that there has to have some costs come out, and we expect to get that done over the course of next year. -------------------------------------------------------------------------------- Kathryn Lynn Huberty, Morgan Stanley, Research Division - MD and Research Analyst [36] -------------------------------------------------------------------------------- Okay. And then lastly, Tim, you mentioned higher reserves in the hospitality business. Can you just talk about where losses are running right now? And where the accruals sit versus, say, what you saw in the business in the financial downturn? -------------------------------------------------------------------------------- Timothy C. Oliver, NCR Corporation - Executive VP & CFO [37] -------------------------------------------------------------------------------- Yes. So we have not seen an increase in the number of defaults. And in fact, we've been very pleased with the reserve levels we had in aggregate. We did take a little bit more on specific customer accounts that turn negative. So these are very specific targeted adjustments. On the remainder of the reserve, I'd say that we are in very good stead for the smaller accounts and for the more general reserves. -------------------------------------------------------------------------------- Operator [38] -------------------------------------------------------------------------------- Moving on, from Oppenheimer, we have Ian Zaffino. -------------------------------------------------------------------------------- Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [39] -------------------------------------------------------------------------------- Great. So can you just delve a little bit more into maybe hospitality and retail and give us a sense of what's driving that business, particularly in retail? Is that all larger customers? Is that one large customer? Is it pretty broad-based? What are you seeing from maybe smaller customers? And maybe do the same exercise for the hospitality business as well. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [40] -------------------------------------------------------------------------------- Yes. Let me just, again, kind of go back at the macro level. So we did a call, end of March, I think, March 30, we did an update call, and shared the mix of our business because I do believe some look at our business and the mix underneath the covers is not as apparent. So we went through retail, and we talked about SEMM or large grocery store chain, big box chains versus department store specialty, which is where the risk is, or SMB, where there might be more risk in retail. We did the same thing in hospitality where we said table service small businesses, they're going to be a little bit more at risk than quick-service restaurants or large chain restaurants. And so if you recall, we kind of added those up and for us, large restaurants, quick-service restaurants are really doing well. And in some cases, their year-over-year numbers are actually quite a bit better than '19. They are thriving in drive-thrus, they're thriving on takeaway. And so those continue to buy and be solid. As you can imagine, we spoke to some of the table service restaurants who are not able to open their doors because maybe they have government restrictions or they haven't been able to get the doors back opened it or get to the volumes. So some of those are where we're seeing some of the difficulty. That business has held up, quite frankly, all things considered pretty well for us. Retail, the large players are continuing to buy. And you're seeing that in our retail strength year-over-year. The impact on the small end. The numbers of SMB and retail is only 5%. Of that whole segment, it's less than 2% of our total revenue. So that really hasn't been an impact to us in terms of overall retail members. And even the department specialists, some of those customers are doing a really nice job online. They shifted the model online or they shifted the model to store pickup. And they're doing well, others have not done quite as well. But again, the total numbers of that risk in retail, total company is around 6% of our total revenue stream. So if you think in totality, the at risk is not as big a number as you might look at the company. And retail has done really well. Hospitality, be at risk is, again, similar numbers. It's 6% of our total business as a company, and that had a little bit more impact on us going forward from COVID. -------------------------------------------------------------------------------- Ian Alton Zaffino, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [41] -------------------------------------------------------------------------------- Okay. And then also, just turning over to banking. You mentioned sort of the hesitation from the customers. Is that driven just COVID uncertainty? Are they seeing the trends somewhere that their customers are acting in a different way that they're not certain of? Or is there just other parts of the customer's house that's just not -- doesn't have the certainty (inaudible). -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [42] -------------------------------------------------------------------------------- Yes. So the banks -- Owen talked about this. So the banks on the digital footprint, a lot of focus on what they can do in digital banking, what you can do on a mobile device, what you can do on the Internet. Not only in our digital banking products, but also other software products. So that spending has continued to be very strong. On the ATM side, when we talk to -- Owen and I call customers every week, we talk to the bankers about what they're doing, they're -- in the second quarter, they saw some slower transactions that you would imagine in April. But the amount of cash being withdrawn was up year-over-year in the second quarter. And the third quarter, they saw transaction volumes coming back. So they still see the transaction volume forecast depending from an ATM. Our bread and butter in ATM is really the complex multifunction machine. And what we're seeing banks look at doing is what are they going to do with their footprint, what any of those branches and as they might shrink the branch footprint or branch hours, they're talking about how a multifunction ATM might pick up some of the slack. So there -- the feedback we're getting, the mindset we're getting is that ATMs is part of their strategy, and they actually call it part of the digital strategy. Going forward, has not changed at all for the banks. They're spending in 2020, they've held on to the money, we've held on to the capital a little bit more than we thought they would have due to -- purely due to COVID. -------------------------------------------------------------------------------- Operator [43] -------------------------------------------------------------------------------- And moving on, ladies and gentlemen, we have our last question from Charles Nabhan, who's with Wells Fargo. -------------------------------------------------------------------------------- Charles Joseph Nabhan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [44] -------------------------------------------------------------------------------- I wanted to ask about the competitive landscape in the hospitality space. Some of your -- provide us more as a private peers in the space have had some struggles. And I was hoping you could comment and maybe give us some color if -- on whether you've seen in bad interest from some of their clients and whether you've been able to gain some markets there in that space? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [45] -------------------------------------------------------------------------------- Well, so hospitality, I'd say, again, that market was more impacted than anybody, particularly in the table service side of COVID. I would say we're really pleased with the work our team has done in helping our clients navigate through COVID. I'd say we're really pleased with some of the innovation they've done in the middle of the pandemic. The team -- (inaudible) and his team rolled out a order at table, which is very different than other order at tables. Instead of just being able to look at the menu, you can actually order from your handheld device when you're an Aloha client or order at table. And then you can pay at that table with that same device when you're done with the meal. So those innovations have really made the conversations and the ability to walk into a customer, whether it's an existing customer or a new customer, and differentiate the capabilities. The team has looked at the comment that you made around some of our competitors and said we're going to double down. We're doing a bliss in a major city that's -- we're putting feet on the street with our local channel, whether they're doing them virtual or whether they're actually going around from restaurants who are open and having a conversation. And so we actually -- again, it's a tough business right now, but we actually feel good about where we're going to come out at the back end of this, adding customers, picking new products up with existing clients. And just focusing on executing our strategy, even in the midst of a pandemic. And Owen, your thoughts on that? -------------------------------------------------------------------------------- Owen J. Sullivan, NCR Corporation - COO [46] -------------------------------------------------------------------------------- Yes. We clearly are seeing quarter-to-quarter the momentum. I think we're getting validation that, to Mike's point, our core product, Aloha Essentials, is really being well received. The notion of being able to go in and offer a total turnkey solution to our customers to do it on a subscription basis. So all of those customers, whether they're working their way through this COVID period or their new start ups. We're minimizing the capital investment upfront by being able to walk in, set them up, put them on a subscription basis. And as Mike talked about, the pace that we have moved, our functionality around this Contactless Commerce, especially in the restaurant, is really being viewed as a positive and aggressive response to, quite frankly, I've heard more customers say they're survival than anything else. So to Mike's point, we're feeling actually pretty good. You mentioned some of our competitors. We know they have been hit. You've probably seen some of their announcements, what the actions they've taken. And contrary to that, as Mike said, we're doubling down on our product investment, our teams out in the field. And we like the early returns that we're getting. -------------------------------------------------------------------------------- Charles Joseph Nabhan, Wells Fargo Securities, LLC, Research Division - Associate Analyst [47] -------------------------------------------------------------------------------- Got it. And then a follow-up. On the M&A strategy, it sounds like you're moving closer to that being part of the conversation again. And I was wondering, do you -- are there any focal points on that strategy that you could highlight? And relative to what you've done in the past, where the focus has been point-of-sale and the digital banking space? -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [48] -------------------------------------------------------------------------------- Yes. I would say the general public is going to be the same. So we've had 3 different buckets. One is a product focus, product focus on the software side. And we've gone kind of 3 significant deals for us. We did D3. We did Zynstra. We did JetPay. And all those trial a formula of buying early-stage companies who have built a really solid product that will fit in with our strategy and allows us to plug it in, integrate it and then cross-sell through our distribution channel. So we will continue to look at products that will follow the same pattern. But I would say it would be all 3 banking, retail and hospitality, where we have an opportunity. We did some deals on channel, particularly in the hospitality where we have gone out and bought channel, bought distribution. Those that worked out great, we talked about kind of reenergizing that channel, the organization, the structure, how we go to market. And those have worked well for us in terms of not only the business, but also financial accretion. And then looking to go for service opportunities, whether they're professional service or global break-fix services or managed services, we think we have the scale and the ability to leverage up if we can find either businesses in a region or businesses that might either be more global. So we'll continue to have the same formula. And the team, we put that on pause as we were focused on cash flow. You can see we did a really nice job. The team did a really phenomenal job of managing cash flow through the first 3 quarters. And we feel much, much better about our clarity in the future. We're not too COVID. But we look at a world today and say, I think Tim used a word, there's less uncertainty than there's certainly lots that we looked at in March. We use that ability to see clearly where we can operate in this environment. We pay down a large portion of our debt that we had put on the balance sheet, just in recognition that we feel much better about the future for our company. -------------------------------------------------------------------------------- Operator [49] -------------------------------------------------------------------------------- All right. Ladies and gentlemen, that will conclude our Q&A session. I'd like to turn the floor back over to Mr. Mike Hayford for any additional or closing remarks today. -------------------------------------------------------------------------------- Michael Dale Hayford, NCR Corporation - President, CEO & Director [50] -------------------------------------------------------------------------------- Thanks. I want to again reiterate what we said, we were very pleased with the third quarter performance in a very challenging environment. Our team did a great job of focusing and execution in, quite frankly, untrusted in a pandemic. We focus, number one, on take care of our clients. Owen talked about the ability to go out and take care of our clients and actually be able to add clients. Secondly, we continued to make progress on our strategic goals. We continue to make investment on our strategic products. We continue to make the shift to a software and service-focused company even during these difficult times. Third, Tim talked about that we improved productivity. We took out cost on a temporary basis, but then we also took actions that would allow those cost savings to carry forward into '21 and beyond. Number four, we drove phenomenal cash flow performance for the third quarter. So we said we're going to focus on cash flow at the start of the year -- or sorry, at the turn of the pandemic, and the team did even better and we could have envisioned on cash flow management. And then last, that allowed us, quite frankly, to pay down some of the debt, so we were able to deleverage and feel very good about where we sit today just with less uncertainty in the environment, recognizing that we can operate at this level and not burn cash but rather generate positive cash flows. So that's what profit us to take down some of our debt. And then lastly, I just want to remind everybody to please plan on joining us on December 3 for our virtual Investor Day, and we will talk more about our strategic goals to drive software and services revenue to 80%, recurring revenue to 60%, and our EBITDA margins to 20% margin. Our 80/60/20 strategic goal. So thank you for joining us today. Thank you, everybody, for participating on our third quarter earnings call. -------------------------------------------------------------------------------- Operator [51] -------------------------------------------------------------------------------- And once again, everyone, we do thank you for joining us. That does conclude our call for today. You may now disconnect.