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NCR > SEC Filings for NCR > Form 10-K on 27-Feb-2014All Recent SEC Filings

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Form 10-K for NCR CORP


27-Feb-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)

BUSINESS OVERVIEW

NCR Corporation is a leading global technology company that provides innovative products and services that enable businesses to connect, interact and transact with their customers and enhance their customer relationships by addressing consumer demand for convenience, value and individual service. Our portfolio of self-service and assisted-service solutions serve customers in the financial services, retail, hospitality, travel, and telecommunications and technology industries and include automated teller machines (ATMs) and ATM and financial services software, point of sale (POS) devices and POS software, self-service kiosks and software applications that can be used by consumers to enable them to interact with businesses from their computer or mobile device. We also complement these product solutions by offering a complete portfolio of services that support both NCR and third party solutions. We also resell third-party networking products and provide related service offerings in the telecommunications and technology sectors.

We have four operating segments: Financial Services, Retail Solutions, Hospitality and Emerging Industries. Each of our lines of business derives its revenues by selling products and services in each of the sales theaters in which NCR operates.

Our solutions are based on a foundation of long-established industry knowledge and consulting expertise, value-added software, hardware technology, global customer support services, and a complete line of business consumables and specialty media products.

NCR's reputation is founded upon over 129 years of providing quality products, services and solutions to our customers. At the heart of our customer and other business relationships is a commitment to acting responsibly, ethically and with the highest level of integrity. This commitment is reflected in NCR's Code of Conduct, which is available on the Corporate Governance page of our website.

2013 OVERVIEW

As more fully discussed in later sections of this MD&A, the following were significant themes and events for 2013:

Revenue growth of approximately 7% compared to full year 2012

Continued growth of higher margin software and services offerings and improvements in revenue mix

Pension underfunded status improved by $372 million compared to 2012

Completed the acquisition of Retalix Ltd.

Entered into a definitive Agreement and Plan of Merger to acquire Digital Insight Corporation for a cash purchase price of approximately $1.65 billion

Issued $400 million aggregate principal amount of 5.875% senior unsecured notes due in 2021, and $700 million aggregate principal amount of 6.375% senior notes due in 2023, to help finance the Digital Insight acquisition


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OVERVIEW OF STRATEGIC INITIATIVES

We have established a focused and consistent business strategy targeted at revenue growth, gross margin expansion, improved customer loyalty and employee engagement. This strategy guided our efforts in 2013, and will continue to guide us in 2014.

To execute this strategy, we incorporate three key imperatives that align with our financial objectives: deliver disruptive innovation; focus on migrating our revenue to higher margin software and recurring services revenue; and more fully enable our sales force with a consultative selling model that better leverages the innovation we are bringing to the market.

Our strategy is summarized in more detail below:

Gain profitable share - We have been working to shift our business model to focus on growth of higher margin software and services revenue, including by focusing our research and development efforts, changing and educating our sales force and executing transformative acquisitions in each of our core lines of business. At the same time, we are continuing our effort to optimize our investments in demand creation to increase NCR's market share in areas with the greatest potential for profitable growth, which include opportunities in self-service technologies with our core financial services, retail, and hospitality customers. We focus on expanding our presence in our core industries, while seeking additional growth by:

         penetrating market adjacencies in single and multi-channel self-service
          segments;


         expanding and strengthening our geographic presence and sales coverage
          across customer tiers through use of the indirect channel; and


         leveraging NCR Services and consumables solutions to grow our share of
          customer revenue, improve customer retention, and deliver increased
          value to our customers.


   Expand into emerging growth industry segments - We are focused on broadening
    the scope of our self-service solutions from our existing customers to expand
    these solution offerings to customers in newer industry-vertical markets
    including telecommunications and technology as well as travel and gaming. We
    expect to grow our business in these industries through integrated service
    offerings in addition to targeted acquisitions and strategic partnerships.


   Build the lowest cost structure in our industry - We strive to increase the
    efficiency and effectiveness of our core functions and the productivity of
    our employees through our continuous improvement initiatives.


   Enhance our global service capability - We continue to identify and execute
    various initiatives to enhance our global service capability. We also focus
    on improving our service positioning, increasing customer service attach
    rates for our products and improving profitability in our services business.
    Our service capability can provide us with a competitive advantage in winning
    customers and it provides NCR with an attractive and stable revenue source.


   Innovation of our people - We are committed to solution innovation across all
    customer industries. Our focus on innovation has been enabled by closer
    collaboration between NCR Services and our lines of business, and the
    movement of our software development resources directly into our various
    lines of business. We also have placed responsibility for hardware
    engineering in our Integrated Supply Chain organization, which is responsible
    for procuring the parts for, and manufacturing, our hardware products.
    Innovation is also driven through investments in training and developing our
    employees by taking advantage of our new world-class training centers. We
    expect that these steps and investments will accelerate the delivery of
    innovative solutions focused on the needs of our customers and changes in
    consumer behavior.


   Enhancing the customer experience - We are committed to providing a customer
    experience to drive loyalty, focusing on product and software solutions based
    on the needs of our customers, a sales force enabled with the consultative
    selling model to better leverage the innovative solutions we are bringing to
    market, and sales and support service teams focused on delivery and customer
    interactions. We continue to rely on the Customer Loyalty Survey, among other
    metrics, to measure our current state and set a course for our future state
    where we aim to continuously improve with solution innovations as well as
    through the execution of our service delivery programs.


   Pursue strategic acquisitions that promote growth and improve gross margin -
    We are continually exploring potential acquisition opportunities in the
    ordinary course of business to identify acquisitions that can accelerate the
    growth of our business and improve our gross margin mix, with a particular
    focus on software-oriented transactions. We may fund acquisitions through
    either equity or debt, including borrowings under our senior secured credit
    facility.


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We are encouraged by our market position for 2014 and are forecasting revenue to be higher than 2013. We plan to continue to manage our costs effectively and balance our investments in areas that generate high returns. Potentially significant risks to the execution of our initiatives include the global economic and credit environment and its effect on capital spending by our customers, competition that can drive further price erosion and potential loss of market share, difficulties associated with introduction of products in new self-service markets, market adoption of our products by customers, management and servicing of our existing indebtedness, and integration of previously completed acquisitions. For further information on potential risks and uncertainties see Item 1A "Risk Factors."

RESULTS FROM OPERATIONS

The following table shows our results for the years ended December 31:

In millions                                      2013     2012     2011
Revenue                                         $6,123   $5,730   $5,291
Gross margin                                    1,740    1,645     951
Gross margin as a percentage of revenue         28.4%    28.7%    18.0%
Operating expenses
   Selling, general and administrative expenses  871      742      890
   Research and development expenses             203      155      209
Income (loss) from operations                    $666     $748    $(148)

The following table shows our revenues and gross margins from products and services, respectively, for the years ended December 31:

In millions                                       2013     2012     2011
Product revenue                                  $2,912   $2,854   $2,592
Cost of products                                 2,152    2,144    2,022
Product gross margin                              $760     $710     $570
Product gross margin as a percentage of revenue  26.1%    24.9%    22.0%
Services revenue                                 $3,211   $2,876   $2,699
Cost of services                                 2,231    1,941    2,318
Services gross margin                             $980     $935     $381

Services gross margin as a percentage of revenue 30.5% 32.5% 14.1%

The following table shows our revenues by theater for the years ended December 31:

                                                                                                   % Increase
                                                                                                   (Decrease)
                                                                                    % Increase      Constant
In millions                           2013    % of Total     2012    % of Total     (Decrease)      Currency
Americas                            $ 3,030      50%       $ 2,823      49%             7 %             8 %
Europe                                1,492      24%         1,459      26%             2 %             1 %
Asia Middle East Africa (AMEA)        1,601      26%         1,448      25%            11 %            18 %
Consolidated revenue                $ 6,123      100%      $ 5,730      100%            7 %             9 %


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2013 compared to 2012 results discussion

Revenue

Revenue increased 7% in 2013 from 2012 due to improvement in our retail solutions, hospitality, and emerging industries lines of business offset by declines in our financial services line of business. The effects of foreign currency fluctuations had a 2% unfavorable impact on revenue for the year. For the year ended December 31, 2013, our product revenue increased 2% and services revenue increased 12% compared to the year ended December 31, 2012. The increase in our product revenue was due to growth in the retail solutions line of business in the Americas, growth in the hospitality line of business in all theaters, and growth in the financial services and emerging industries lines of business in the AMEA theater partially offset by declines in the financial services line of business in the Americas. The increase in our services revenue was primarily attributable to increases in professional and installation services, maintenance services and software as a service (SaaS) in the retail solutions line of business in the Americas and AMEA theaters, in the hospitality line of business in all theaters and in the financial services line of business in the AMEA theater, partially offset by declines in professional and installation services and maintenance services in the emerging industries line of business in the Americas theater.

Gross Margin

Gross margin as a percentage of revenue was 28.4% in 2013 compared to 28.7% in 2012. Product gross margin in 2013 increased to 26.1% compared to 24.9% in 2012. During 2013 and 2012, product gross margin was adversely affected by approximately $36 million and $19 million, respectively, of acquisition related amortization of intangibles. Product gross margin in 2013 was also negatively impacted by $14 million in lower pension benefit, or 0.5% as a percentage of product revenue, year over year. After considering these items, the product gross margin increased due to favorable sales mix with an increase in software revenue.

Services gross margin decreased to 30.5% in 2013 compared to 32.5% in 2012. Services gross margin in 2013 was negatively impacted by $68 million in lower pension benefit, or 2.1% as a percentage of services revenue, year over year. After considering this item, the increase in services gross margin was due to a favorable mix of revenues, including an increase in SaaS revenues.

2012 compared to 2011 results discussion

Revenue

Revenue increased 8% in 2012 from 2011 due to improvement in our financial services and hospitality lines of business offset by declines in our retail solutions and emerging industries lines of business. The effects of foreign currency fluctuations had a 3% unfavorable impact on revenue. For the year ended December 31, 2012, our product revenue increased 10% and services revenue increased 7% compared to the year ended December 31, 2011. The increase in our product revenue was due to growth in the financial services line of business in the Americas, Europe and AMEA theaters, and growth in the hospitality line of business in the Americas theater offset by declines in the retail solutions line of business in the Americas and Europe theaters. The increase in our services revenue was primarily attributable to increases in professional and installation services and maintenance services in the financial services and hospitality lines of business in the Americas theater offset by declines in such services in the retail solutions line of business in the Americas and Europe theaters.

Gross Margin

Gross margin as a percentage of revenue was 28.7% in 2012 compared to 18.0% in 2011. Product gross margin in 2012 increased slightly to 24.9% compared to 22.0% in 2011. During 2012 and 2011, product gross margin was adversely affected by approximately $19 million and $6 million, respectively, of acquisition related amortization of intangibles. Product gross margin was positively impacted by $37 million in lower pension expense, or 1.3% as a percentage of product revenue, year over year. After considering these items, the product gross margin increased due to favorable sales mix with an increase in software revenue.

Services gross margin increased to 32.5% in 2012 compared to 14.1% in 2011. Services gross margin was positively impacted by $454 million in lower pension expense, or 15.8% as a percentage of services revenue, year over year. After considering this item, the increase in services gross margin was due to lower labor and service delivery costs.


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Effects of Pension, Postemployment, and Postretirement Benefit Plans

NCR's income from continuing operations for the years ended December 31 was
impacted by certain employee benefit plans as shown below:
In millions               2013     2012    2011
Pension (benefit) expense $(78)   $(224)   $582
Postemployment expense     18       37      46
Postretirement benefit    (15)     (14)    (13)
Total (benefit) expense   $(75)   $(201)   $615

In 2013, pension benefit decreased to $78 million compared to $224 million in 2012 and expense of $582 million in 2011. In 2013, the pension benefit included actuarial gains of $104 million driven by increases in discount rates used to value the U.S. and certain international plans and $15 million associated with the termination of NCR's U.S. non-qualified pension plans. Additionally, the 2013 pension benefit included special termination benefit costs of $26 million related to U.S. employees who irrevocably accepted a voluntary early retirement offer during 2013. In 2013, approximately 41% of the pension benefit was included in selling, general and administrative and research and development expenses, with the remaining 59% included in cost of products and services. In 2012, the pension benefit included actuarial gains of $293 million related to remeasurement of the U.S. pension obligations in the fourth quarter of 2012, which primarily included the impact of the voluntary lump sum offer to certain participants of the U.S. qualified pension plan that was completed in the fourth quarter of 2012. In 2011, pension expense included actuarial losses of $570 million driven by significant decreases in discount rates used to value the U.S. and international pension plan obligations.

Postemployment expense (severance and disability medical) was $18 million in 2013 compared to $37 million in 2012 and $46 million in 2011. During the first quarter of 2013, NCR amended its U.S. separation plan to eliminate the accumulation of postemployment benefits. This amendment resulted in a curtailment benefit of approximately $13 million. The decrease in postemployment expense in 2012 was primarily related to $6 million of Radiant acquisition related severance costs incurred in 2011.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $129 million to $871 million in 2013 from $742 million in 2012. As a percentage of revenue, these expenses were 14.2% in 2013 and 12.9% in 2012. In 2013, selling, general and administrative expenses include $22 million of pension benefit, $46 million of acquisition related costs, $29 million of amortization of acquisition related intangible assets and $3 million of legal costs related to the previously disclosed OFAC and FCPA internal investigations. In 2012, selling, general and administrative expenses included a pension benefit of $66 million, $23 million of acquisition related costs, $19 million of amortization of acquisition related intangible assets and $4 million of legal costs related to the previously disclosed OFAC and FCPA internal investigations. After considering these items, selling, general and administrative expenses remained consistent as a percentage of revenue at 13.3%, primarily due to a $7 million gain on the sale of an office property in 2013 offset by investment in sales resources during 2013.

Selling, general, and administrative expenses decreased $148 million to $742 million in 2012 from $890 million in 2011. As a percentage of revenue, these expenses were 12.9% in 2012 and 16.8% in 2011. In 2012, selling, general, and administrative expenses included a pension benefit of $66 million, $23 million of acquisition related costs, $19 million of amortization of acquisition related intangible assets and $4 million of legal costs related to the previously disclosed OFAC and FCPA internal investigations. In 2011, selling, general, and administrative expenses included $162 million of pension costs, $37 million of acquisition related costs, and $6 million of amortization of acquisition related intangible assets. After considering these items, selling, general and administrative expenses increased as a percentage of revenue to 13.3% in 2012 from 12.9% in 2011 primarily due to additional investments in sales resources.


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Research and Development Expenses

Research and development expenses increased $48 million to $203 million in 2013 from $155 million in 2012. As a percentage of revenue, these costs were 3.3% in 2013 and 2.7% in 2012. Research and development expenses included pension benefit of $10 million in 2013 as compared to pension benefit of $30 million in 2012. After considering this item, research and development expenses slightly increased to 3.5% in 2013 from 3.2% in 2012 as a percentage of revenue and are in line with management expectations as we continue to invest in broadening our self-service solutions.

Research and development expenses decreased $54 million to $155 million in 2012 from $209 million in 2011. As a percentage of revenue, these costs were 2.7% in 2012 and 4.0% in 2011. Research and development expenses included a $30 million pension benefit in 2012 as compared to pension expense of $57 million in 2011. After considering this item, research and development expenses slightly increased to 3.2% in 2012 from 2.9% in 2011 as a percentage of revenue and are in line with management expectations as we continue to invest in broadening our self-service solutions.

Interest and Other Expense Items

Interest expense was $103 million in 2013 compared to $42 million in 2012 and $13 million in 2011. Interest expense in 2013 was primarily related to the Company's senior unsecured notes and borrowings under the Company's senior secured credit facility. The increase in 2013 compared to 2012 is primarily related to a full year of interest expense related to the Company's senior unsecured notes in 2013 compared to a partial year of interest expense in 2012. The increase in 2012 compared to 2011 is primarily related to a full year of interest expense related to the Company's senior secured credit facility that was entered into in August 2011.

Other (expense) income, net was $9 million in 2013 compared to $8 million in 2012 and $3 million in 2011. Interest income was $6 million in 2013, $6 million in 2012, and $5 million in 2011. In 2013, other (expense) income, net included $13 million related to losses from foreign currency contracts not designated as hedging instruments as well as from foreign currency fluctuations and $7 million in bank related fees partially offset by income from the sale of certain patents and a $3 million gain on the sale of an investment. In 2012, other (expense) income, net included $7 million related to the impairment of an investment, $5 million in bank related fees and $2 million related to losses from foreign currency fluctuations. In 2011, other (expense) income, net included $7 million related to losses from foreign currency fluctuations partially offset by income from the sale of certain patents and a benefit of $3 million from final settlement of a litigation matter.

Income Taxes

The effective tax rate was 18% in 2013, 32% in 2012, and 40% in 2011. During 2013, we recorded a one-time benefit of approximately $16 million in connection with the American Taxpayer Relief Act of 2012 that was signed into law in January 2013 and the related retroactive tax relief for certain law provisions that expired in 2012. The 2013 tax rate was also favorably impacted by the release of a $10 million valuation allowance due to the implementation of a tax planning strategy to access certain deferred tax assets, a $15 million reduction in a valuation allowance related to a subsidiary in Japan, and a favorable mix of earnings by country, primarily related to lower pension benefit. During 2012, we favorably settled examinations with Canada for the 2003 tax year and Japan for tax years 2001 through 2006 that resulted in tax benefits of $14 million and $13 million, respectively. In addition, the 2012 tax rate was favorably impacted by the mix of earnings by country. These benefits were partially offset by an increase of $17 million to the U.S. valuation allowance for deferred tax assets, primarily related to tax attributes expiring by 2015. During 2011, we favorably settled examinations with Canada for 1997 through 2001 that resulted in a $12 million tax benefit.

During 2011, the Internal Revenue Service commenced an examination of our 2009 and 2010 income tax returns, which is ongoing. While we are subject to numerous federal, state and foreign tax audits, we believe that appropriate reserves exist for issues that might arise from these audits. Should these audits be settled, the resulting tax effect could impact the tax provision and cash flows in future periods. During 2014, the Company expects to resolve certain tax matters related to U.S. and foreign jurisdictions. These resolutions could have a material impact on the effective tax rate in 2014.


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Income (Loss) from Discontinued Operations

For the year ended December 31, 2013, loss from discontinued operations was $9 million, net of tax, solely related to environmental matters, which was due to changes in estimates related to the Fox River reserve in addition to accruals for litigation fees related to the Kalamazoo River environmental matter, partially offset by recoveries from insurance carriers.

For the year ended December 31, 2012, income from discontinued operations was $6 million, net of tax, which includes a $4 million operating loss from the Entertainment business, an $8 million benefit from favorable changes in uncertain tax benefits related to Teradata and a $2 million benefit from an insurance recovery from a previously agreed settlement related to the Fox River environmental matter.

For the year ended December 31, 2011, loss from discontinued operations was $93 million, net of tax, which includes a $96 million operating loss from the Entertainment business, a $1 million operating loss from the closure of NCR's EFT payment processing business in Canada, and a $4 million operating loss from the divestiture of our healthcare solutions business, offset by $2 million of income from environmental matters which included the favorable impact of changes in estimates related to the Fox River reserve offset by an accrual for litigation fees related to the Kalamazoo River environmental matter and an accrual for anticipated future disposal costs related to an environmental matter in Japan, and a $6 million benefit from favorable changes in uncertain tax benefits attributable to Teradata.


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Revenue and Operating Income by Segment

As described in Note 13, "Segment Information and Concentrations" of the Notes to Consolidated Financial Statements, the Company manages and reports its businesses in the following segments:

Financial Services - We offer solutions to enable customers in the financial services industry to reduce costs, generate new revenue streams and enhance customer loyalty. These solutions include a comprehensive line of ATM and payment processing hardware and software and cash management and video banking software, and related installation, maintenance, and managed and professional services. We also offer a complete line of printer consumables.

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