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NCR > SEC Filings for NCR > Form 10-Q on 2-May-2014All Recent SEC Filings

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Form 10-Q for NCR CORP


2-May-2014

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (MD&A)

Overview
The following were the significant events for the first quarter of 2014, each of which is discussed more fully in later sections of this MD&A:
Revenue increased approximately 8% from the prior year period;

We continued to experience significant growth in software-related revenue (which we measure by combining software license and maintenance revenue, software as a service (SaaS) revenue and professional services revenue associated with software delivery); and

Completed the acquisition of Digital Insight.

We have established a focused and consistent business strategy targeted at revenue growth, gross margin expansion, improved customer loyalty and employee engagement. To execute this strategy, we incorporate three key imperatives that align with our financial objectives for 2014 and beyond: deliver disruptive innovation; focus on migrating 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, which we continued to pursue in the first quarter of 2014, 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 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 have focused 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 emerging industry-vertical markets
    including telecommunications and technology, travel and small business. 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 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 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.


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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.

We expect to continue with these initiatives for the remainder of 2014 and beyond, as we refine our business model and position the Company for growth and profitability. 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.

Results from Operations

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013


The following table shows our results for the three months ended March 31:
                                                  Three months ended March 31
In millions                                         2014              2013
Revenue                                            $1,518            $1,410
Gross margin                                        $416              $369
Gross margin as a percentage of revenue             27.4%             26.2%
Operating expenses
   Selling, general and administrative expenses     $245              $229
   Research and development expenses                 63                55
Income from operations                              $108               $85

The following table shows our revenues and gross margins from products and services for the three months ended March 31:

                                                   Three months ended March 31
In millions                                          2014              2013
Product revenue                                      $634              $667
Cost of products                                      476               503
Product gross margin                                 $158              $164
Product gross margin as a percentage of revenue      24.9%             24.6%
Services revenue                                     $884              $743
Cost of services                                      626               538
Services gross margin                                $258              $205
Services gross margin as a percentage of revenue     29.2%             27.6%


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The following table shows our revenues by theater for the three months ended March 31:

                                                                                       % Increase
                                                                                       (Decrease)
                                                                           % Increase   Constant
In millions                      2014   % of Total     2013   % of Total   (Decrease)   Currency
Americas                         $780      51%         $736      52%           6%            8 %
Europe                           365       24%         321       23%          14%           12 %
Asia Middle East Africa (AMEA)   373       25%         353       25%           6%           12 %
Consolidated revenue            $1,518     100%       $1,410     100%          8%           10 %

Revenue

For the three months ended March 31, 2014 compared to the three months ended March 31, 2013, revenue increased 8% due to to improvement in our financial services, hospitality, and emerging industries lines of business. Digital Insight generated $76 million of revenue in the three months ended March 31, 2014. Foreign currency fluctuations unfavorably impacted the year-over-year comparison by 2%. Our product revenue decreased 5% and our services revenue increased 19% year-over-year. The decrease in our product revenue was due to declines in the financial services and retail solutions lines of business in the Americas theater and declines in the retail solutions and emerging industries lines of business in the AMEA theater partially offset by growth in the financial services line of business in the Europe and AMEA theaters, growth in the retail solutions line of business in the Europe theater, growth in the hospitality line of business in all theaters, and growth in the emerging industries line of business in the Americas theater. The increase in our services revenue was primarily attributable to increases in professional and installation services, maintenance services and software as a service (SaaS). Services revenue increased in the financial services, retail solutions and hospitality lines of business across all theaters and increased in the emerging industries line of business in the Americas and Europe theaters.

Gross Margin

Gross margin as a percentage of revenue in the first quarter of 2014 was 27.4% compared to 26.2% in the first quarter of 2013. Product gross margin in the first quarter of 2014 was 24.9% compared to 24.6% in the first quarter of 2013. Product gross margin in the first quarter of 2014 was negatively impacted by $2 million in higher acquisition-related amortization of intangibles, or 0.3% as a percentage of product revenue. Excluding this item, product gross margin increased primarily due to a favorable sales mix. Services gross margin in the first quarter of 2014 was 29.2% compared to 27.6% in the first quarter of 2013. Services gross margin in the first quarter of 2014 was negatively impacted by $6 million in higher acquisition-related amortization of intangibles, or 0.7% as a percentage of services revenue. Excluding this item, services gross margin increased in the first quarter of 2014 due to a favorable mix of revenues, including an increase in SaaS revenues.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $245 million in the first quarter of 2014 as compared to $229 million in the first quarter of 2013. As a percentage of revenue, these expenses were 16.1% in the first quarter of 2014 compared to 16.2% in the first quarter of 2013. Selling, general and administrative expenses in the first quarter of 2014 included $14 million of acquisition-related costs, $14 million of acquisition-related amortization of intangibles and $1 million of OFAC and FCPA related legal costs. Selling, general, and administrative expenses in the first quarter of 2013 included $16 million of acquisition-related costs, $6 million of acquisition-related amortization of intangibles, and $1 million of OFAC and FCPA related legal costs. Excluding these items, selling, general and administrative expenses decreased as a percentage of revenue due to focus on expense management initiatives.

Research and Development Expenses

Research and development expenses were $63 million in the first quarter of 2014 as compared to $55 million in the first quarter of 2013. As a percentage of revenue, these costs increased to 4.2% in the first quarter of 2014 as compared to 3.9% in the first quarter of 2013 and are in line with management expectations as we continue to invest in broadening our solutions.


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Interest and Other Expense Items

Interest expense was $43 million in the first quarter of 2014 compared to $21 million in the first quarter of 2013. Interest expense increased in the first quarter of 2014 primarily as a result of interest payable on the Company's senior unsecured notes. Other expense, net was $7 million in the first quarter of 2014 compared to other income, net of $2 million in the first quarter of 2013. Other expense, net in the first quarter of 2014 primarily included losses from foreign exchange contracts not designated as hedging instruments and foreign currency fluctuations. Other income, net in the first quarter of 2013 primarily included a gain on the sale of an investment.

Provision for Income Taxes

Income tax provisions for interim (quarterly) periods are based on estimated annual income tax rates calculated separately from the effect of significant or unusual items. Income tax expense was $4 million for the three months ended March 31, 2014 compared to $2 million for the three months ended March 31, 2013. The increase in income tax expense was primarily driven by the one-time benefit of approximately $16 million included in the three months ended March 31, 2013 in connection with the American Taxpayer Relief Act of 2012 that was signed into law in January 2013. The increase was partially offset by discrete benefits of $12 million in the three months ended March 31, 2014, including a favorable change in uncertain tax positions.
NCR is subject to numerous federal, state and foreign tax audits. While NCR believes 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.

Revenue and Operating Income by Segment

The Company manages and reports its businesses in the following four 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; cash management, video banking and customer-facing digital banking software; and related installation, maintenance, and managed and professional services. We also offer a complete line of printer consumables.

Retail Solutions - We offer solutions to customers in the retail industry designed to improve selling productivity and checkout processes as well as increase service levels. These solutions primarily include retail-oriented technologies, such as point of sale terminals and point of sale software; on omni-channel retail software platform with a comprehensive suite of retail software applications; innovative self-service kiosks, such as self-checkout; as well as bar-code scanners. We also offer installation, maintenance, managed and professional services and a complete line of printer consumables.

Hospitality - We offer technology solutions to customers in the hospitality industry, serving businesses that range from a single store or restaurant to global chains and sports and entertainment venues. Our solutions include point of sale hardware and software solutions, installation, maintenance, managed and professional services and a complete line of printer consumables.

Emerging Industries - We offer maintenance as well as managed and professional services for third-party computer hardware provided to select manufacturers, primarily in the telecommunications industry, who value and leverage our global service capability. Also included in the Emerging Industries segment are solutions designed to enhance the customer experience for the travel and gaming industries, such as self-service kiosks, and the small business industry, such as an all-in-one point of sale solution. Additionally, we offer installation, maintenance, and managed and professional services.

Each of these segments derives its revenues by selling products and services in the sales theaters in which NCR operates. Segments are measured for profitability by the Company's chief operating decision maker based on revenue and segment operating income. For purposes of discussing our operating results by segment, we exclude the impact of certain items (described below) from segment operating income, consistent with the manner by which management reviews each segment, evaluates performance, and reports our segment results under accounting principles generally accepted in the United States of America (otherwise known as GAAP). This format is useful to investors because it allows analysis and comparability of operating trends. It also includes the same information that is used by NCR management to make decisions regarding the segments and to assess our financial performance.


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The effect of pension (benefit) expense on segment operating income, which was a benefit of $1 million in the first quarter of 2014 and an expense of $7 million in the first quarter of 2013, has been excluded from the operating income for each reporting segment presented below. Additionally, we have excluded other significant, non-recurring items from our segment operating results. Our segment results are reconciled to total Company results reported under GAAP in Note 13, "Segment Information and Concentrations" of the Notes to Condensed Consolidated Financial Statements.

In the segment discussions below, we have disclosed the impact of foreign currency fluctuations as it relates to our segment revenue due to its significance during the quarter.

Financial Services Segment

The following table presents the Financial Services revenue and segment
operating income for the three months ended March 31:

                                             Three months ended March 31
In millions                                      2014             2013
Revenue                                          $794             $714
Operating income                                 $103              $57
Operating income as a percentage of revenue     13.0%             8.0%

The Company completed the acquisition of Digital Insight on January 10, 2014. As a result, the revenue and operating income results for the Financial Services segment include the impact of Digital Insight from January 10, 2014 through March 31, 2014. Digital Insight generated $76 million of revenue and $23 million of operating income in the quarter.

Financial Services revenue increased 11% during the first quarter of 2014 as compared to the first quarter of 2013. The increase was driven by growth in product sales and services revenue in the Europe and AMEA theaters and growth in services revenue in the Americas theater, which includes the impact of the Digital Insight business, partially offset by declines in product sales in the Americas theater. Foreign currency fluctuations had an unfavorable impact on the year-over-year revenue comparison by 3%.

Operating income was $103 million in the first quarter of 2014 as compared to $57 million in the first quarter of 2013. The increase in operating income was driven by a higher mix of software revenue and the contribution of the Digital Insight business as noted above.

Retail Solutions Segment

The following table presents the Retail Solutions revenue and segment operating
income for the three months ended March 31:

                                             Three months ended March 31
In millions                                     2014             2013
Revenue                                         $490             $489
Operating income                                $36              $41
Operating income as a percentage of revenue     7.3%             8.4%

Retail Solutions revenue increased slightly to $490 million during the first quarter of 2014. The results in the first quarter of 2014 were driven by higher product sales and services revenue in the Europe theater and higher services revenue in the Americas and AMEA theaters offset by declines in product sales in the Americas and AMEA theaters. Foreign currency fluctuations had an unfavorable impact on the year-over-year revenue comparison by 1%.

Operating income was $36 million in the first quarter of 2014 as compared to $41 million in the first quarter of 2013. The decrease in the Retail Solutions operating income was primarily due to an unfavorable mix of revenue and continued investment in the business.


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Hospitality Segment

The following table presents the Hospitality revenue and segment operating
income for the three months ended March 31:


                                             Three months ended March 31
In millions                                    2014              2013
Revenue                                        $149              $131
Operating income                                $12              $21
Operating income as a percentage of revenue    8.1%             16.0%

Hospitality revenue increased 14% during the first quarter of 2014 as compared to the first quarter of 2013. The increase was driven by higher product sales and services revenue in all theaters. Foreign currency fluctuations had an unfavorable impact on the year-over-year revenue comparison by 1%.

Operating income for Hospitality was $12 million in the first quarter of 2014 as compared to $21 million in the first quarter of 2013. The decrease was driven by an unfavorable mix of revenue and continued investment in the business.

Emerging Industries Segment

The following table presents the Emerging Industries revenue and segment
operating income for the three months ended March 31:


                                             Three months ended March 31
In millions                                    2014              2013
Revenue                                         $85              $76
Operating income                                $4               $10
Operating income as a percentage of revenue    4.7%             13.2%

The Emerging Industries segment revenue increased 12% during the first quarter of 2014 as compared to the first quarter of 2013. The increase was driven by higher product sales and services revenue in the Americas theater and higher services revenue in the Europe theater, partially offset by declines in product sales in the AMEA theater. Foreign currency fluctuations did not impact the year-over-year revenue comparison.

Operating income was $4 million in the first quarter of 2014 and $10 million in the first quarter of 2013. The decrease in operating income was negatively impacted by on-boarding costs associated with managed services contracts.


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Financial Condition, Liquidity, and Capital Resources

Cash provided by operating activities was $31 million in the three months ended March 31, 2014 and cash provided by operating activities was $21 million in the three months ended March 31, 2013. The increase in cash provided by operating activities was primarily driven by increased profitability in the three months ended March 31, 2014.

NCR's management uses a non-GAAP measure called "free cash flow" to assess the financial performance of the Company. We define free cash flow as net cash provided by (used in) operating activities and cash provided by (used in) discontinued operations, less capital expenditures for property, plant and equipment, less additions to capitalized software, plus discretionary pension contributions and settlements. We believe free cash flow information is useful for investors because it relates the operating cash flows from the Company's continuing and discontinued operations to the capital that is spent to continue and improve business operations. In particular, free cash flow indicates the amount of cash available after capital expenditures for, among other things, investments in the Company's existing businesses, strategic acquisitions, repurchase of NCR stock and repayment of debt obligations. Free cash flow does not represent the residual cash flow available for discretionary expenditures, since there may be other non-discretionary expenditures that are not deducted from the measure. Free cash flow does not have a uniform definition under GAAP, and therefore NCR's definition may differ from other companies' definitions of this measure. This non-GAAP measure should not be considered a substitute for, or superior to, cash flows from operating activities under GAAP. The table below reconciles net cash provided by (used in) operating activities to NCR's non-GAAP measure of free cash flow for the three months ended March 31:

                                                          Three months ended March 31
In millions                                                 2014              2013
Net cash provided by operating activities                    $31               $21
Less: Expenditures for property, plant and equipment        (32)              (24)
Less: Additions to capitalized software                     (34)              (21)
Net cash (used in) provided by discontinued operations      (16)                1
Free cash used (non-GAAP)                                   $(51)             $(23)

The increase in expenditures for property, plant and equipment and capitalized software was due to continued investment in the business as well as research and development. The change in cash flows from discontinued operations was driven by increases in Fox River transaction and remediation costs as well as the timing of payments from indemnification parties.

Financing activities and certain other investing activities are not included in our calculation of free cash flow. Other investing activities primarily include business acquisitions, divestitures and investments as well as proceeds from the sales of property, plant and equipment. During the three months ended March 31, 2014, we completed the acquisition of Digital Insight for $1.64 billion, net of cash acquired. During the three months ended March 31, 2013, we completed multiple acquisitions that totaled $681 million, net of cash acquired, including the acquisition of Retalix Ltd. for $664 million, net of cash acquired.

Our financing activities primarily include proceeds from employee stock plans, repurchase of NCR common stock and borrowings and repayments of credit . . .

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