NCR Corporation

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.

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.

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 we review our third quarter financial numbers, then Owen, Tim, and I will take your questions. I'll begin on slide four 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 focused 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 three quarters of the year. Tim will discuss in more detail the drivers of our strong free cash flow production. 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 temporary 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 hardware sales to be the most challenged. Now moving to slide five, 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 six 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 is a top five U.S. bank that recently agreed to a multi-year 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 are experiencing 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 bundles software, services, hardware, and payments, continued in the third quarter. This model is proving itself in our ability to attract 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 were sold as a subscription bundle, with payments attached 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.

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 six, which presents a top-level overview of our third quarter financial performance, as you can see, we added a rolling five-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 in 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 pause, but the year-over-year decline did improve from the second quarter. And in fact, revenue was up 7 percent versus our second quarter results. We'll dig into the more specific drivers of the decline by business unit, but in aggregate, $165 million, or 85 percent of that decline, is attributable to lower hardware revenue, which was down 26 percent. As Mike described in his remarks, our continued effort to shift to recurring revenue streams again accelerated sequentially. we shifted $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 quarters 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. In 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 expanded 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're of 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 discussion of revenue, the shift to recurring revenue was 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 three quarters of last year. Moving to slide seven, 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 bank's 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 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 initiatives 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 eight, 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 nine, slide nine 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 one time 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 multi-year 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 were 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 3.1 times, 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 de-risk 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 de-lever, 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 3.3 times well under our debt covenant maximum of 4.75 times. And my last slide is slide 12, which provides a description of the three 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 two new bond offerings for $650 million at 5% and $450 million at 5.25% with maturities of eight and 10 years respectively. We use these proceeds, augmented by $200 million of existing cash, to redeem our prior $600 million 5% senior notes and $700 million 6 and 3-8 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 and 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 a 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 a lower interest and dividends. And with that, I'll turn it back to Mike for his closing comments.

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 3rd. 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?

Thank you, sir. And ladies and gentlemen, for any questions here at this time, please press star 1 to join the queue. Just make sure you have your mute function turned off to allow us to receive that signal. Again, at this time, that's star 1 for any questions. And we'll pause for just a quick moment. All right, and first from RBC Capital Markets, we have Dan Perlin.

Yes, good evening. It's actually Matt Roswell filling in for Dan. I hope everyone's doing well. A couple 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?

Yeah, so we... had originally announced beginning of the year that we would do about $90 million of cost takeout in 2020. And as you 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 takeout that we could do. We took down some salaries of some of the executives. Obviously, 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 the second half of the year. I think we called it 2020.5. 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... 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. Okay.

Switching to the banking business, with hardware, I think with the ATM business sort of being about 200, 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?

Yeah, you know, obviously we had a strong ATM year last or this year. We've seen the banks be a little more cautious on some of their spending, on discretionary spending, particularly on the ATMs. 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 timeframe. 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 products, and those continue to have pretty good strength here in 2020 versus ATMs, which have slowed down

Yes, we've been running for the last several quarters at about $220 million a quarter in ATMs, and it's been relatively consistent for the last three. 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 would 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.

Okay, one more question if you'll let me. Switching over to hospitality, looks like Aloha is seeing great demand. Are you excited are you seeing an acceleration in the shift to sort of the services model? You mentioned the essentials bundle. I mean, is that pandemic-driven? Is that you all doing it? Or is that just, you know, it's time and it's happening?

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 uptake 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 need help getting up and running, and they want simplicity. They want a single vendor who can come and deliver a full turnkey to run run their restaurant, so I think that's part of it, but I think the primary driver is the shift in our business model.

Alright, moving on. Our next question is from Stevens. We have Brett Huff. Please go ahead.

Yeah, hey guys. This is Joel. I'm for Brett. Thanks for taking our questions. 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? Thank you.

Well, 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 of really changing the in particular 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. You know, time to time, we're probably going to lose one or two, a handful here and there. But we feel really good that we're not adding in 2019, that we will not add in 2020. in terms of the marketplace. And so I think that competitive aspect is exactly what I thought was going to happen. 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 digital. I don't know, Owen,

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 it 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.

Our next question will come from Dan Kernos, who's with the Benchmark Company.

Great, thanks. Maybe, Mike, if you could just give us some geographic color on what you're seeing would just be helpful, and I'll leave it to you if you want to break it down by segment or not. And then just as we think about sort of, you know, the COVID-driven industry, evolution of the entire landscape. I know that, you know, 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, you know, some of the verticals that we're seeing develop here?

Yeah, let me, I'll start the last one in terms of, you know, so the COVID impacts and where we see that week. 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 of the pandemic, the 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 was going to be similar on a year-over-year. We did a little better in the third quarter than last. Then second quarter, if you look at year-over-year comparisons, I think we were 12% constant currency in the second quarter, a little better in the third quarter. I think now we would look at it and say we don't see the health care resolved 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 with in the first quarter. So when do we start to see, when we say over, when do we get normality? When can people go better? 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 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 stacks, which is an expensive part of our capital structure. And then we announced on 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. Maybe, Tim, you just want to comment just on how we kind of view 2020 into 2021 from a numbers perspective.

Yeah, I think we're likely to see that this quarter play out again, meaning the third quarter, the fourth quarter's 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 places. I suspect the mix will be relatively similar as well. I also expect that we'll 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. or an immediate. We're making this shift to much more permanent productivity initiatives that will drive future period profitability and make that a more sustainable improvement to margin rate. 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 we saw on Q3 was outsized to our typical Q3 performance. I think Q4 will be That'll 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 positive and demonstrably so.

And then just maybe Mike, you know, obviously they're, or Owen, you know, the ATM is understandable. I know that nobody's 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? Are you thinking about, you know, how are you thinking about that in conjunction with obviously the strength you're seeing in digital?

Right. Yeah, I would say that the conversations are, 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 they'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 have been seeing the 220 to 250 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. But 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.

Moving on, we have Matt Somerville with D.A. Davidson.

Thanks. Just a couple 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?

No, we're not. I think there's a couple 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, Give it a performance standpoint 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've moved our software from perpetual to subscription. which has clearly changed behavior at end of 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 timeline. 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.

Got it. And then maybe if you guys can spend a couple minutes or a couple seconds just talking a little bit about what you mean in the self-checkout environment. If demand there remains strong, incoming orders backlog, and if you think that strength, you know, has, you know, multi-year sort of legs underneath it given the you know, the shift towards more friction light transactions.

Yeah, I mean, we, you know, self-checkout or being able to manage your own interaction with, you know, effectively self-pick at a store had been making a shift, and we've been seeing that solid. The pandemic... prices obviously we think accelerated that and will continue to push that forward. So the ability to walk 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 the self-checkout device. when you do the scanning. So we think that that business is solid. We think that this will give it some strength going forward, and we certainly saw that in the third quarter.

Tim, do you want to speak to the numbers? 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, looking forward, the order book is strong.

From JP Morgan, we have Paul Chong.

Hey, guys. Thanks for taking my question. So just to follow up on self-checkout, can you kind of walk us through the unit economics of a sale? you know, the ASP of the solution for hardware standpoint and then the, you know, relevant operating margins and then the services and software kind of offering over time and then, you know, the life cycle. So, for example, the Watson Group announcement, you know, based on number of stores, can we get to a number, free cash flow number from this deal over time?

Yeah, I mean, I'll just, you know, generically say Every deal is maybe a little differently depending on where they're at, 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 assisted lanes and self-checkout lanes. As I referenced before, as we've gotten 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. I think self-checkout is even more unique each individual sale versus maybe what we even see in the ATM market.

Thanks for that. 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?

First Horizon was actually, they were already a D3 client. So what we announced in the press release is they actually took and ported. They were running that on-prem in-house. We ported that. We're now managing. We're managing in the cloud. That's an AWS cloud instance. We're seeing most of the D3 clients wanting to move to the cloud. It gives the flexibility, the scale up rapidly. You can see peaks. That's one of the huge advantages of that product set. And we're seeing most people, I shouldn't say most, we're seeing clients like that say, we want you, NCR, to help run that for us. The First Horizon also had a large acquisition, so we brought on that additional volume onto the DT 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 a relationship that we've had for a number of years.

Our next question comes from Katie Huberty with Morgan Stanley.

Thank you. Good afternoon. 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 the last couple of quarters, or does that mean that revenue is flat sequentially?

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 a percent or two. But I do think that as we sit here today, demand particularly in the things that we can measure easily like hardware looks to be very similar to what demand was in Q3.

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 banks. It's really a tale of two halves. 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 start to thaw 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 They're too busy executing, and this year in particular, too busy running their stores to really be popping a bunch of new SCOs on the floor. So, you know, again, we think it's going to be slightly sequential up from third quarter, but maybe not the big pop we've seen in prior fourth quarters.

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 costs fast enough that you will be able to offset that and you can continue to expand EBITDA margins in the medium term?

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.

Okay. And then lastly, Tim, you mentioned higher reserves in the hospitality business. Could 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 downturns?

Yes, we have not seen an increase in the number of defaults. 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 turned negative. So these were 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.

That's great. Thank you. Sure.

Moving on from Oppenheimer, we have Ian Zafino.

Great, thank you. Can we 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 pretty broad-based? What do you think of maybe smaller customers and and maybe we could do the same exercise for the hospitality business as well. Thanks.

Yeah, let me just, again, kind of go back at a macro level. So we did a call end of March, I think March 30th, we did an update call and shared the mix of our business because I do believe some look at our business and think, the mix underneath the covers is not as apparent. So we went through retail and we talked about FDMM or large grocery store chain, big box chain 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 are 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're thriving on 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 open 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 numbers. And even 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 at-risk and 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 a company. And retail has done really well. Hospitality, the at-risk is, again, similar numbers. It's about 6% of our total business as a company. And that's had a little bit more impact on us going forward from COVID-19.

Okay. Um, you know, and then also just turning over to banking, um, you know, you mentioned sort of the hesitation from the customers. Is that driven just, um, COVID uncertainty? Are they, are they seeing a trend somewhere that their customers are, um, 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, um,

Yeah, so the banks, you know, 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 practice but also our other software practice. 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 talked to the bankers about what they're doing. 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. In the third quarter, they saw transaction volume coming back. So they still see the transaction volume for cash dispensing from an ATM. Our bread and butter in ATMs 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 are they going to do with branches? And as they might shrink a branch footprint or branch hours, they're talking about how a multifunction ATM might pick up some of the slack. So the feedback we're getting, the mindset we're getting, is that ATMs as part of their strategy, and they actually call it part of the digital strategy going forward, has not changed at all for the banks. Their spending in 2020, They've held on to the money. They've held on to the capital a little bit more than we thought they would have, purely due to COVID.

Okay, great. Thanks for the call, again.

And moving on, ladies and gentlemen, we have our last question from Charles Naben, who's with Wells Fargo.

Hi, thank you for taking my question. I wanted to ask about the competitive landscape in the hospitality space. Some of your private competitors in the space have had some struggles, and I was hoping you could comment and maybe give us some color on whether you've seen inbound interest from some of their clients and whether you've been able to gain some market share in that space.

Well, you know, 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, Dirk Izzo 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 a menu, you can actually order from your handheld device when you're an Aloha client with 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 conversation 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 comments that you made around some of our competitors and said, we're going to double down. We're doing a blitz in a major city this week. We're putting feet on the street with our local channel, whether they're doing that virtual or whether they're actually going around to restaurants who are open and having a conversation. And so we actually, again, that's a tough business right now, but we actually feel good about where we're going to come out of 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. I don't know, Owen, your thoughts on that.

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 is to do it on a subscription basis. So all of those customers, whether they're working their way through this COVID period or they're new startups, we're minimizing the capital investment up front 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 their 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.

Got it. And as 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, are there any focal points on that strategy that you could highlight relative to what you've done in the past where the focus has been, you know, point of sale and the digital banking space?

Yeah, I would say, you know, the general focus is going to be the same. So we've had three different buckets. One is product focus, product focus on the software side, and we've done kind of three significant deals for us. We did D3, we did ZenStron, we did JetPay, and all those followed 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 that same pattern, but I would say it would be all three, banking, retail, and hospitality, where we have an opportunity. We've done some deals on channel, particularly in hospitality, where we've gone out and bought channel, bought distribution. Those that worked out great, we talked about kind of re-energizing that channel, the organization, the structure, how we go to market, and those that worked well for us in terms of not only business but also financial accretion. And then we'll continue to look for service opportunities, whether that's 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 even be more global. So we'll continue to follow the same formula. And the team, we put that on pause as we were focusing on cash flow. You can see we did a really nice job. The team did a really phenomenal job at managing cash flow through the first three quarters. And we feel much, much better about our clarity in the future. We're not through COVID. So we look at the world today and say, I think Tim used the word, there's less uncertainty than there certainly was when we looked at it 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.

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. Thanks.

I just 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, an unprecedented pandemic We focused, number one, on taking 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 continued to make investment on our strategic products. We continued to make the shift to a software and service-focused company even during these difficult times. Tim talked about this. We improved productivity. We took our costs both 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 our third quarter. So we said we're going to focus on cash flow at the start of the year, sorry, at the start of the pandemic, and the team did even better than we could have envisioned on cash flow management. And then lastly, that allowed us quite frankly to pay down some of the debt so we were able to be leveraged 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 earn cash, but rather generate positive cash flows. That's what prompted 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 3rd 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 goals. So thank you for joining us today. Thank you, everybody, for participating on our third quarter earnings call.

And once again, everyone, we do thank you for joining us. That does conclude our call for today. You may now disconnect.