NCR Corporation beats earnings expectations. Reported EPS is $0.71, expectations were $0.63.
Operator: Good day and welcome to the NCR Corporation Second Quarter Fiscal Year 2023 Earnings Conference Call. Today’s conference is being recorded. At this time. I’d like to turn the conference over to Mr. Michael Nelson, Treasurer and Vice President of Investor Relations. Please go ahead.
Michael Nelson: Good afternoon and thank you for joining our second quarter 2023 earnings call. Joining me on the call today are Mike Hayford. CEO, Owen Sullivan, President and COO, Tim Oliver, CFO and CEO Designate of NCR Atleos; and David Wilkinson, President of our Commerce Business and CEO Designate of NCR Voyix. 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 released in our periodic filings with the SEC, including our annual report.
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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 August 2, 2023 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.
Mike Hayford: Thanks, Michael. I will begin with some of my views on the business. And I’ll also provide an update on our previously announced intention to separate NCR into two publicly traded companies. Tim will then review our financial performance and then Owen, Tim and I will take your questions. Let’s begin on Slide 5 with some of the highlights from the first quarter. First, NCR delivered strong performance that included solid recurring revenue growth and significant margin expansion and delivered over $150 million of free cash flow, which has allowed us to delever prior to the spin. Back end, we are on track to separate NCR into two public companies in the fourth quarter of 2023. Following Tim’s comment on our financial results, I will provide an update on those separation activities.
Third, in the second quarter, we had slight year-on-year revenue growth on a constant currency bases and 5% recurring revenue growth also on a constant currency basis. It’s important to note that the revenue growth would have been 4% year-on-year without the impact of shifting to subscription. Fourth, adjusted EBITDA increased 17% on a constant currency basis from the second quarter of 2022. Adjusted EBITDA margin expanded to 19.6% this quarter, which represents a 260 basis point increase from the second quarter of 2022. And finally, NCR generated $154 million in free cash flow in the quarter. Over the past three quarters, we have generated over $550 million in free cash flow, allowing us to reduce financial leverage ahead of the separation.
Moving to the business update on Slide 6, we have strong momentum across all five of our business segments with progress against our strategic initiatives across all of our KPIs. In retail, we continue to deliver on our strategy to be the retail platform company of choice. During the second quarter, NCR achieved multiple platform lane wins as retailers choose the best path for them to the platform. The Save Mart company’s a California based grocery store operating approximately 200 stores selected Emerald as their next gen point of sale. We also continue our market leadership position in self-checkout. RBR announced that NCR once again was the market share leader in self-checkout with more than twice the share of the next largest supplier. This marks in fact 20th consecutive year that NCR has been the market leader in self-checkout solutions.
In hospitality, we continue to experience strong demand across our enterprise and SMB customers. In SMB, our payments attach rate for customers remains approximately 90% driving a 45% increase in payment sites. In Enterprise Firebirds Wood Fired Grill who chose the NCR Aloha for its point of sale. Aloha with the NCR commerce platform will provide a cloud-based solution to transform and connect all of Firebirds’ fine dining restaurants across 21 states. In digital banking, we continue to have positive momentum. In the second quarter, digital banking sales activity was strong, with nine new customer deals and 18 digital banking renewals. We also continue to experience strong cross-sell, plus upsell momentum. In the second quarter, Synovus, which has over $60 billion in assets, renewed its digital banking relationship with NCR and added the Terafina Small Business deposits module.
In payments and network, we are making progress in both merchant acquiring and the Allpoint network. North America ATM withdrawals and cash dispense continue to increase and remain at a six year high. International market expansion continues to accelerate. During the second quarter, we signed an agreement to deploy NCR’s Cashzone ATMs and provide access to cash for travelers in the Barcelona airport, which is one of the busiest airports in Europe. In self-service banking, we continued our momentum in our ATM as a Service solution. Interest in our offering is accelerating for both community banks and large FIs globally. In the second quarter, we signed 10 new ATM service deals including Kiwibank and UnionBank of the Philippines. UIP is transferring operational maintenance and management of its ATM fleet which includes over 400 ATMs to NCR.
The bank will increase operational efficiencies while strengthening compliance and security. And the Seacoast Bank, which streamline operations with NCR, NCR’s ATMs as a Service solution also extended customers access to cash by joining the Allpoint network. With that, let me pass it over to Tim.
Tim Oliver: Thanks, Mike. And thanks to all of you for joining us today. I’ll start on Slide 7, with a top level overview of our second quarter, which show every guided metric we were at the higher end or above the guidance we provided back in May. As Mike summarized in the second quarter, we drove substantial growth and recurring revenue, expanded our profit margins, particularly gross margin, and generated $154 million of free cash flow. We continue to execute cost productivity actions that are and will generate incremental savings to offset any dis-synergy arising from the planned separation. This quarter’s results are demonstrative of the exceptional effort of our teams to simultaneously drive financial results, accelerate our strategic plans and ready the company for the pending separation transaction.
Starting in the top left, revenue was roughly $2 billion down 1% year-on-year as reported, and flat on a constant currency basis. The revenue composition consisted of a richer mix of software and services. Hardware revenue had a particularly difficult year-on-year comparison. You’ll remember then that a year ago Q2, we recognized about $50 million of hardware revenue that was pushed out of the first quarter due to supply chain and transportation issues. Most importantly, recurring revenue was up 4% year-on-year and up 5% adjusted for FX. We continue to have success transitioning from one-time perpetual sales into multiyear subscription based revenue streams. In the second quarter, we shifted nearly $80 million of high profit revenue from what would have been previously recognized upfront to recurring revenue that will convert over the next several years.
This intentional deferral of upfront revenue to recurring revenue lowered total revenue growth by four full points. The strong U.S. dollar compared to the year ago period, and an unfavorable impact of $18 million, primarily within our retail and self-service banking segments. If we were to adjust for FX and the shift to recurring revenue, total revenue growth would have been about 4%. In the top right, adjusted EBITDA increased $50 million year-on-year to $389 million, up 15% year-on-year as reported, and up 17% on a constant currency basis. Foreign currency exchange rates had an unfavorable impact of $6 million. Adjusted EBITDA margin expanded 260 basis points from the second quarter of 2022 to 19.6%. The increase in margin was driven by lower direct costs, such as reductions in fuel, shipping and component costs, as well as the impact of indirect cost mitigation actions and a higher margin revenue mix.
The benefit of lower direct costs similarly added 310 basis points to adjusted gross margin rate. In the bottom left reported non-GAAP EPS with $0.94, up $0.03 or 3% year-on-year as reported, and up 9% on a constant currency basis. The strength of the U.S. dollar reduced EPS by about $0.05. The non-GAAP tax rate was 26.2% versus 19.2% in the prior year, and that impacted EPS by another $0.09. The prior year tax rate benefited from a favorable provision and a tax reserve adjustment. And finally, we generated $154 million of free cash flow for both higher profitability and the anticipated improvements in working capital. Back in October, we described our desire to generate at least $500 million of free cash flow, before the separation transaction to reduce our financial leverage.
In the first three quarters of those five, we have already exceeded that bogey on a strong financial position heading into the separation. Moving to Slide 8, which shows our Retail segment results. Starting in the top left, retail revenue increased 2% year-on-year as reported an increase 3% adjusted for FX driven by growth in software and services. We also shifted roughly $30 million of high profit revenue that would previously have occurred upfront to recurring revenue that will be recognized over the next four to seven years. This intentional deferral of upfront revenue to recurring revenue, lowered revenue growth in retail by six points. Adjusted for FX and the shift to recurring revenue, retail revenue would have grown at almost 9%. Second quarter adjusted EBITDA increased 18% year-on-year and 21% adjusted for constant currency, resulting from improvements in component labor and freight costs, as well as other cost mitigation and pricing actions taking the latter part of 2022 and in 2023.
The adjusted EBITDA rate was 21.4%, up 290 basis points over the prior year. The bottom of the slide shows the Retail segment key performance indicators. On the left, our platform lanes a KPI that illustrates the success of our strategy to convert our retail customers to our platform based subscription model. We increased our number of platform lanes by 28,000 lanes, or 81%, year-on-year. At the time of conversion to platform lane drives an incremental $400 in ARR, or an increase of $11 million versus last year. The platform lane increase was driven by rollouts in major convenience to fuel customers. While platform lanes currently represent less than 5% of our total lanes, we see accelerating momentum for the conversion of our traditional lanes and have a substantial lane conversion backlog.
And once on the platform, the opportunity to cross-sell and upsell new features and functionality drives further ARPU expansion. In the center bottom is our self-checkout revenue, self-checkout revenue was down 2% year-on-year. Timing of major hardware rollouts in the second quarter of last year versus the third quarter of this year caused that comparative temporal dislocation. And ARR was up 3% year-on-year, similar to the impact on revenue, currency rates did modestly negatively affect the ARR calculations, including this one. Turning to Slide 9 showing our hospitality results. Hospitality revenue declined $3 million or 1%. Lower POS hardware sales were largely offset by an increase in services and software revenue, including cloud services and payment processing.
Adjusted EBITDA was up 30% year-on-year, adjusted EBITDA margin rate expanded 620 basis points to a multiyear high of 25.5%. A richer mix of software and services revenue, pricing and cost reductions all helped push margin rates higher. Hospitalities, key strategic metrics in the bottom of this slide include platform sites, payment sites, and ARR. Platform sites increased 9%. Payment sites increased 45% and ARR was up 8% year-on-year on higher ARPU at both new platform and new payments sites. The average conversion to platform sites currently drives an incremental $7,000 a year in ARR. While the average conversion of payment sites currently drives an incremental $4,000. Combined, the additional platform sites and payment sites contributed an incremental $25 million in ARR year-on-year.
We continue to see strategic momentum in this business as enterprise client’s transition to the platform and expand their functionality and SMB clients attached payments. Turning to Slide 10, which shows our Digital Banking segment, digital banking revenue increased 7% year-on-year, driven by client wins, strong renewal momentum, and cross-sell success at Terafina and the channel put service platform. We expect second half revenue growth in this business to accelerate to about 10%. Adjusted EBITDA was down 5% year-on-year due to an investment in sales, marketing and R&D to grow this business faster. Adjusted EBITDA margin rate was 37.9%. Digital Banking’s key strategic metrics in the bottom of this slide include registered users, active users, and ARR.
Registered users increased 8%, active users increased 6% and ARR was up a similar 6%. At Slide 11, we do some easy math to help you evaluate the combined segments of Retail, Hospitality and Digital Banking. These segments will form NCR Voyix at the separation transaction. This roll up is for directional indications only. The eventual financials for this company will be impacted by currently unallocated corporate costs by revenue profit adjustments that reflect the planned perimeter of the transaction, and by synergies or dis-synergies that result from the spin. The combined revenue for these segments increased $20 million or 2% year-on-year as reported, and 3% adjusting for currency. Recurring revenue was up 5% year-on-year. The combined adjusted EBITDA was up 16% year-on-year, adjusted for FX and adjusted EBITDA margin rate expanded by 270 basis points to 24.8%.
Let’s move to Slide 12, turning back to our currently reported segments, in this case, the Payments and Network segment. Starting at the top left, payments and network revenue was flat year-on-year as reported, and up 1% adjusted for FX. Adjusted EBITDA increased 2% year-on-year as reported and 3% adjusted for FX. Adjusted EBITDA margin rate expanded 50 basis points and winning 29.7% driven by a richer mix of high value transactions, which more than offset higher cash rental costs. Because our cash rental costs are calculated using short-term interest rates and are recognized as cost of goods, they have a significant drag in results. That said, our hedging program algorithm and operational optimization and pricing adjustments have mitigated much of the impact of interest rates.
ATM cash rental costs increased $35 million year-on-year on a gross basis and $12 million on a net basis after these mitigation efforts. The bottom of this slide shows payments and network key strategic metrics. On the bottom left endpoints increased 1% year-on-year. In the center bottom are transactions, our KPI that illustrates the payments processed across our Allpoint network and across our Merchant acquiring networks. Transactions were up 2% year-on-year on a trailing 12-month basis fueled by an ATM withdrawal growth rate of 7%. The rise in both the frequency of cash withdrawals and the amount of cash withdrawn per transaction led to an increase, the total amount of cash dispense globally to a level, the highest we’ve seen in better part of a decade.
Annual recurring revenue in this business increased 1% year-on-year. Slide 13, shows our Self-Service Banking segment results. Self-service banking revenue was down 3% as reported and down 1% on a constant currency basis, primarily due to the intentional shift of recurring revenue, which resulted in lower ATM hardware revenue reported in this quarter. Recurring revenue was up 10% on FX adjusted basis over the prior year. We continue to have success transitioning our self-service banking business from one-time perpetual sales into multiyear subscription-based revenue streams. During the quarter, we shifted roughly $36 million in revenue, they would have been upfront previously to recurring revenue. The intentional deferral of upfront revenue from recurring revenue, lowered revenue growth by five points.
Adjusted for FX and the shift to recurring revenue, self-service banking revenue growth would have been closer to 4%. Adjusted EBITDA increased 19% year-on-year and was up 22% on FX consistent basis, adjusted EBITDA margin expanded 470 basis points to 25.6%. The remarkable margin expansion from the previous year can be credited to the reduction in direct costs, particularly in expenses related to fuel and components, as well as the increase in higher margin recurring revenue streams. The bottom of the slide shows our self-service banking key metrics on the left, software and services revenue mix increased 200 basis points to 69%. ATM as a Service units increased 304% year-on-year to 18,000 units. And the shift to recurring revenue continues to gain traction, driving ARR up 7% year-on-year.
On Slide 14, similar to the review presented on Slide 11 with similar caveats. This slide showcases the combined segment results for payments and network and self-service banking, which are the segments that will comprise NCR Atleos at the time of the separation. As I said before, the unallocated revenue and corporate costs are not reflected here. The combined revenue for these two segments declined $18 million or 2% year-on-year as reported and 1% adjusted for currency. The reduction was primarily driven by the intentional shift to recurring revenue. Recurring revenue increased 4% year-on-year as reported and 6% adjusted for currency. And the combined adjusted EBITDA was up 14% year-on-year adjusted for FX. Adjusted EBITDA margin expanded 330 basis points to 26.4%.
Turning to Slide 15, which describes free cash flow, net debt and adjusted EBITDA metrics to facilitate leverage calculations. As we said before, we generated $154 million of free cash flow in the quarter driven by higher profitability and an improvement in working capital. Day sales outstanding improved by three days and days of inventory improved by two days sequentially. Our goal to generate $500 million in free cash flow, before the separation transaction to reduce financial leverage has been well communicated. We have now generated over $550 million of free cash flow in the first three of those five quarters. The slide also displays, our net debt to adjusted EBITDA metric, which has improved to a leverage ratio of 3.4 times, down from four times in Q2 of 2022.
Driven by higher profitability, and higher cash generation. We remain well within our debt covenants, and have significant liquidity with over $900 million available under our revolving credit facility. We have a robust balance sheet, ample liquidity and strong financial stability, to support our growth and the spin transaction. And finally, on Slide 16, we reiterate our full year 2023 guidance that we provided back at the beginning of the year. That said, after a solid first quarter and a very strong Q2, we now expect to be at the higher end of all of these guided ranges, for all financial metrics. And for those of you building models, we expect to further the trend of sequential quarterly improvement in revenue and profitability, and each of the remaining two quarters of 2023.
With that, Mike I’ll send it back to you.
Mike Hayford: Thanks, Tim. And I’m going to continue on Slide 17 with the NCR separation roadmap. Our go- to-market teams are organized by industry under General Manager Unit. These teams are ready and have been ready for the spin. Additionally, there are areas of shared services functions such as legal, tax, HR, Treasury, IT and others that are well underway in the process of preparing for the separation. We continue to make progress in our process with the SEC, and recently submitted amendment to a Form-10 registration statement. We have already submitted a letter with the Internal Revenue Service regarding the tax free nature of the separation. At this time, we are expecting the timing of the separation to be in the fourth quarter as disclosed in the Form-10.
The timing of the separation is subject to a number of conditions, in particular being declared effective by the SEC and the state of the capital markets. At this time, we believe the capital markets are favorable to us completing a spin. Once we receive regulatory approval, we will raise new debt and then execute the spin. In closing on Slide 18. Looking forward, our key priorities are clear. First, we are on track to separate NCR into two public companies in the fourth quarter. Upon separation, we believe each company will benefit from increased operating and financial flexibility in pursuit of its respective and distinct opportunity sets. Second, we believe that spinning off NCR Atleos in a tax free distribution is the best path to unlock shareholder value.
But should other alternative options become available in the future that could deliver superior value, such as a whole or partial company sale of NCR. The Board continues to remain open to considering these alternative scenarios. Third, we have made significant strategic progress transforming NCR to a software led as a Services company. We have momentum, and a clear strategic vision as we transition customers onto our software and payments platforms with customers on the platform increasing their, spend with NCR. Fourth, we expect to continue our quarterly operating and financial improvements. And finally, I’d like to extend an invitation to each of you to participate in our Virtual Investor Day for both debt and equity investors which is scheduled for September 5 of this year.
We are looking forward to the event and intend to take a deep dive into our strategy and strategic goals for both NCR Voyix and NCR Atleos. This concludes our prepared remarks for today. With that we will open the call for questions. Operator, please open the line for questions.
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Q&A Session
Operator: Thank you. [Operator Instructions] Our first question comes from Charles Nabhan with Stephens.
Charles Nabhan: Hi, guys, thank you for taking my question. Had a two part question on free cash flows and leverage post spin. First on the free cash flow, it’s good to see things trending stimuli ahead of schedule. And I know you’re guiding to the top end of that $400 million to $500 million range. My question there is, given the trajectory of free cash flows, is it presumable to potentially expect upside to that 500 million or are there any factors like, that were – positive factors that were pulled forward? And then my second part of that question is just how to think about leverage initially post spin, I know you haven’t recapitalized the business as yet, but any color around that would be would be helpful?
Tim Oliver: Yes, sure. So on cash generation thus far this year, we knew that we had about $200 million of cash flow that we should have delivered last year, that we used to support working capital and went through some supply chain issues in 2022. And we committed to harvesting that across Qs 4, 1 and 2. And so, it’s been a very strong cash conversion period. And we’ve, for instance for a year ago, we’re done $149 million in inventory alone, our receivables past dues are down. So, we’ve done a great job of managing working capital to get us back to a level, that’s let’s call it sustainable. There’s not a lot of cash to be harvested from excess working capital at this point for the remainder of the year. So our conversion at this point, be more, closer to profitability, I expect profitability to be higher in each of the next two quarters.
And I expect to generate around $100 million or so a quarter over the next two quarters, that would put us through the high end of our range. But remember that there are going to be one-time cash costs associated with the spin that we need to absorb. So, I didn’t take that range up only to say we will need to invest some cash back into the transaction and pay all of our advisors and all the rest to get this thing done. But even with that $100 million or so outflow associated with one-time cost during the spin period will be at the high end of our guided range.
Charles Nabhan: Got it that’s really helpful.…
Tim Oliver: There was leverage coming out.
Charles Nabhan: On leverage…
Tim Oliver: We’ll be in market right after Labor Day and weekend to start to try to place the debt that we need. We think that it’s going to be about $2.5 million of debt on a net basis, some more like $2.9 million on a gross basis for SpinCo. Atleos will then have a leverage ratio, north of 3.5 and the 3.7 range out of the gate, and will likely work hard to pay that down into the 3 range as quickly as possible.
Charles Nabhan: Got it.
Tim Oliver: RemainCo then, or Voyix, will have will be about to be north of 3, but South of 3.5. I’m thinking 3.2, 3.3 if that business as we exit, and that – remember they’ll keep most of the existing debt that’s already outstanding, which has a very favorable coupon. And so – their interest expense will be somewhat lower. I think that business will also likely delever a little bit more post spin and can get safely down below 3 and then probably move toward 2.5 overtime.
Charles Nabhan: Got it? Okay. And as a follow-up one of your peers and I guess customers as well and Euronet noticed some a slowdown in cash withdrawal activity in Europe. And I know you’re not as exposed to DCC and cross border as they are. But if you could just quickly comment on some of the trends you’re seeing across Europe in terms of cash withdrawal activity?
Tim Oliver: Yes, so globally, our cash withdrawal activity was up. And as I said in the discussion earlier, not only were the numbers of cash withdrawal transactions up, but the amount of cash being withdrawal being withdrawn is up. That’s true in the U.S. to a larger degree than it is in Europe. But in the U.K., we still saw more cash dispensed and more transactions.
Mike Hayford: And I would say our new markets, Portugal, Greece, some of the Southern European markets where we opened up new endpoints, we’re seeing actually pretty good growth activity in those markets. So contrary to what you raised.
Charles Nabhan: Got it. Quick hit color, guys. Thank you.
Mike Hayford: Sure. Our pleasure.
Operator: And our next question comes from Matt Summerville with D.A. Davidson.
Matt Summerville: Thanks. Good evening. Just a couple of questions. First on the retail business, Tim, in your prepared remarks, you mentioned a little bit of a timing dynamic. Could you touch on that again, because it sounded like it may impact the third quarter of this year if I heard you correctly. Could you just talk through that?