NCR Corp

LSE:0K45

Earnings Call Transcript 2020-Q3

[Operator]

Good day ladies and gentlemen, and welcome to today’s NCR Corporation’s Third Quarter Fiscal Year 2020 Earnings Call. A quick reminder that today’s conference is being recorded.

And at this time, I would like to turn the floor over to Mr. Michael Nelson, the Vice President of Investor Relations. Please go ahead, sir.

[Michael Nelson, Vice President-Investor Relations]

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 will 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.

[Mike Hayford, President and Chief Executive Officer]

Thanks, Michael and thank you everyone for joining us today. I will begin with an overview of our third quarter performance and an update on our progress executing against our strategic initiatives. Before turning it over to Tim, who will review our third quarter financial numbers, then Owen, Tim and I will take your questions.

I’ll begin on Slide 4 with the highlights from the third quarter. NCR delivered solid performance despite the current business and operating challenges that continue to be impacted by COVID-19. Our teams have continued to show resiliency in these unprecedented times and continue focus on taking care of our customers.

On our last call, I noted that NCR would start shifting management attention from the pandemic and instead get more focused on growing our business during the second half of 2020 versus the first half of the year. In the third quarter, we have successfully taken steps down that path.

First, one of the primary highlights of the third quarter was our strong free cash flow generation. We delivered $150 million of free cash flow in the quarter and $299 million of free cash flow through the first three quarters of the year. Tim will discuss in more details the drivers of our strong free cash flow production.

Second, we expanded EBITDA margin to 15.7% in the third quarter, which represents an increase of 220 basis points from the second quarter, and an increase of 10 basis points from the third quarter of 2019. As we discussed on our second quarter earnings call when the pandemic began, we focused on reducing cash costs. In the third quarter, we began to execute the productivity improvement initiatives that were temporary sideline 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 5. We have forged ahead executing our strategy despite unprecedented market disruption. We have added new customers, deepened our relationship with existing customers and continued to invest in our strategic growth products like digital banking, Aloha cloud; Emerald, our retail cloud POS and payments.

We will continue to focus on a 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 recurring revenue model that previously would have been sold as an upfront software license.

One example of the top five U.S. bank that recently agreed to a multi-year recurring software agreement to move to our Activate Enterprise, NextGen 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 experience demand across customers and geographies as consumer preferences accelerate. We continue to be excited about the sales funnel of our Emerald offering, which is our next-gen, cloud-based retail point-of-sale solution.

In hospitality, the momentum of Aloha Essentials, which bundle software, services, hardware and payments continued in the third quarter. This model is proving itself in our ability to 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 attach rate also strong at roughly 80% for sales into new sites.

As we drive the transformation of our business, we will strive to be even more efficient and effective stewards 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.

[Tim Oliver, Chief Financial Officer]

Thank you, Mike and thanks to all of you on the phone for tuning in today. As it’s been our practice, my comments will again, presume a constant currency adjustment that removes the impact of foreign exchange. So, this quarter currency had only a minor impact.

Starting then on Slide 6, which presents a top level overview of our third quarter financial performance, as you can see, we added a rolling 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% versus our second quarter results.

We will dig into the more specific drivers of the decline by business unit, but in aggregate, $165 million or 85% of that decline is attributable to lower hardware revenue, which was down 26%. As Mike described in his remarks, our continued effort to shift to recurring revenue streams again, accelerated sequentially. We 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 quarter or $22 million in this year’s second quarter. Sequentially, all of our business units showed growth and impressively revenue in our retail business was actually up year-over-year.

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 extended by 220 basis points. This expansion was the 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 take 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 in 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 pasty receivables, on cash cycle linearity, and on raw and finished goods 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 7, which describes our Banking segment results. Banking revenue decreased $165 million or 17%, mainly driven by a 40% decline in ATM hardware sales. Our hardware sales remain 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 million to $250 million per quarter and we anticipate this range will persist at least for the next couple of quarters.

Most of the remaining decline in banking revenue can be attributed to the service revenue associated with a forgone 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 that was put in place earlier in the year. Operating expenses were down 4%.On a sequential basis, revenue was up 2% and operating margin expanded by 60 basis points.

Moving to slide 8, which shows our retail segment results. Retail revenue increased $17 million or 2%. Last quarter, we discussed the delay for installing self-checkout units at several of our largest customers, as many of these customers were too busy operating their stores during the pandemic to undertake an installation project. as anticipated, these orders were delayed and not canceled. In the third quarter, we delivered some of those orders. As a result, self-checkout revenue experienced strong double-digit growth.

in concert with revenue, operating income was up $9 million or 25%. The increase was driven by higher revenue, as well as by discretionary spending and cost initiatives taken earlier this year. operating expenses were down 7%. On a sequential basis, revenue was up 15% and operating margin expanded by 460 basis points.

Turning to slide 9. slide 9 shows our Hospitality segment results. hospitality revenue decreased $43 million or 20%, driven primarily by lower hardware sales. As expected, our Hospitality segment has been the most impacted by the coronavirus with capacity limitations and changes to our customers’ behaviors. Third quarter operating income declined $3 million, mainly due to the flow-through impact from lower revenue while we were able to reduce operating expenses by 17% with our cost initiatives, prudently higher reserves on accounts receivable offset some of those savings. On a sequential basis, revenue was up 8% and operating margin expanded by 400 basis points.

Turning to slide 10, we provide our third quarter revenue results under our previous operating segments for both continuity and color. Software revenue decreased $44 million or 9% due to the shift from 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 standard 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 in 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. In the beginning of April, we issued a $400 million bond as a precautionary measure to derisk our balance sheet and ensure financial flexibility in uncertain times.

The cumulative effect of all those actions was a very solid balance sheet with sufficient liquidity and no significant near-term debt maturities. We ended the third quarter with $1.6 billion of cash, having already reduced our term note debt by $200 million. Since that time, we’ve executed a couple of other transactions to delever, which I’ll update on the next slide. We remain well within our debt covenants, and ended the third quarter with credit facility leverage of approximately 3.3 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 2023, 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, 6.38% 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 lower interest and dividends.

And with that, I’ll turn it back to Mike for his closing comments.

[Mike Hayford, President and Chief Executive Officer]

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 solution. We will continue to allocate capital in our strategic growth platform such as digital banking, Emerald, next generation aloha payments and digital-connected services. We will also consider acquisitions and paying down debt.

Third, we will continue to focus on driving significant free cash flow generation, which go hand in hand with advancing our strategy. Fourth, we are building momentum across the business for improved execution and performance in 2021.

And lastly, I’d like to extend an invitation to each of you to participate in our Virtual Investor Day, which is scheduled for December 3. we are looking forward to an event; 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?

[Operator]

Thank you, sir. [Operator Instructions] All right. And first from RBC Capital Markets, we have Dan Perlin.

[Matt Roswell, RBC Capital Markets]

Yes. Good evening. It’s actually Matt Roswell filling in for Dan. Hope everyone’s doing well. A couple of quick questions; first of all, on the margins and the cost reduction efforts, how much of what you had planned to do earlier in the year before pandemics hit, do you think you’ve accomplished and sort of how much is left?

[Mike Hayford, President and Chief Executive Officer]

Yes. So, we originally announced at the beginning of the year that we would do about $90 million of cost takeout in 2020. and as we call it a pandemic hit, we put that at all, we didn’t think was appropriate during very difficult time to be letting our employees go. So, we deferred any actions other than kind of a cost take-out that we could do. We took down some salaries that some of the executives have discretionary spend we would do and so some of those savings flowed into third quarter.

on the second quarter call, we talked about getting back to focus on executing our business in second half of the year, I think we call it 20, 20.5. And we said as part of that we’re going to get our cost structure aligned with our business. So, we did some of those actions in the third quarter. We have plans to continue to 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.

[Matt Roswell, RBC Capital Markets]

Okay. Switching to the banking business, with hardware, I think it’s – with the ATM business sort of being about $200 million, $250 million quarter, I think is what he said. Given the growth in digital and the other products, when do you sort of see a kind of a crossover point meaning ATM businesses kind of flattish, but then you actually see growth, because of the other pieces?

[Mike Hayford, President and Chief Executive Officer]

Yes. obviously, we had a strong ATM last year and this year, we’ve seen the bank feeling more cautious on some of their spending – on discretionary spending. Particularly, 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 taught the last couple of years, our ATM business is still an important part of our strategy. 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 to a fair to do. Tim, if you want to add to…

[Tim Oliver, Chief Financial Officer]

yes. We’ve been running for the last several quarters at about $220 million a quarter on ATMs. And it’s been relatively consistent for the last three. I would expect for the next couple that’ll remain true as well. I don’t know at what point in time, banks will loosen up their capital spending. We would hope that there’d be a little pickup when that happens. But we ought to have easier comparisons in q1 next year, and be relatively flattish from an ATM perspective, which will allow the rest of our banking business to demonstrate its growth. I’d also like to say that in this quarter of the first one in a while, non-ATM hardware was higher in terms of revenue than ATM hardware was.

[Matt Roswell, RBC Capital Markets]

Okay. one more question if you allow me. switching over to hospitality, it looks like aloha seeing great demand. Are you seeing an acceleration in the shift to sort of the services model? You mentioned the central bundle? I mean, is that pandemic driven? Is that you all doing it? Or is that just – it’s time and it’s happening?

[Mike Hayford, President and Chief Executive Officer]

Well, I’d say 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 payment. 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 attachment 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 certainly, the market need help getting up and running and they want subsidy. They want a single bet can come and deliver a full turnkey to run their restaurant. So, I think that’s part of this, I think the primary driver is a shift in our business model.

[Operator]

All right. moving on to our next questions from Stephens, we have Brett Huff. please go ahead.

[Joel Hoeffler, Stephens]

Yes. Hey, guys, this is Joel on 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 can 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.

[Mike Hayford, President and Chief Executive Officer]

Well, I mean, I’ll start with the competitiveness. We talked about this – last year, we talked about this, this year. So last year, our team there, led by Doug Brown, did a phenomenal job, fairly changing, in particular, the digital insight, in terms of focus on customers and retention, and being able to start adding accounts. as they get into 2020, they continue to do that. I mean, we compete with everybody out there. We certainly believe we’re winning. competitively, time-to-time, where we’re probably going to lose one or two, handful here and there, but we feel really good that we’re not adding in 2019 – that we will not add 2020 in terms of the marketplace. And so I think that competitive aspect is exactly what doesn’t 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 Owen will speak to it. But that’s what customers talk about is the shift to the potential. Owen, want to add some color there?

[Owen Sullivan, Chief Operating Officer]

I think consistent with what both Tim and Mike talked about what we are clearly seeing as a step-up in investment from the banks on their digital platforms. We’re seeing it both with the digital insight and D3 product. we’re seeing with the rest of the banking platform that we have in the market and it’s coming across in license, it’s coming across in the professional services space. And I believe we have talked about the step-up although we haven’t disclosed the growth. That’s not something we’ve put out there yet in terms of end market growth rates. but we clearly are seeing and this is COVID, enhanced a pickup in our customers and consumer activity on the digital platform.

[Operator]

Our next question comes from Dan Kurnos, who is with the Benchmark Company.

[Dan Kurnos, The Benchmark Company]

Great, thanks. Maybe, Mike, can you just give us some geographic color on what you’re saying, will 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 this – the COVID driven evolution of the entire landscape. I know that you guys have done a great job with free cash right now, which probably gives you some of the MoU you want to go back to doing some of your tuck-ins. but how do you view that on the tech side versus maybe, partnership opportunities that could get you deeper penetrated into some of the verticals that we’re seeing develop here.

[Mike Hayford, President and Chief Executive Officer]

Yes. Let me I’ll throw the last one in terms of sort of the COVID impacts and where we see that. we’ve talked at this quarterly call and obviously, back in March and April, when this thing first, it was kind of hard to see the depth or the duration of, quite frankly, the pandemic, the health issue. But nonetheless, we had to make some assumptions. But I think we already said second quarter is going to be difficult. We said third quarter is going to be similar on a year-over-year. We did a little better in the third quarter than second quarter. If you look at year-over-year comparisons, I think we were 12% constant currency in the second quarter, a little better than the third quarter. I think now we would look at it and say, we don’t we don’t see the healthcare result yet.

And so it’s probably going to bleed a little bit into 2021. 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, oh, when we get normality [ph], when people can go back to restaurants, when we can go to stores and operate normal? So, we think that pushed into next year, we did, as you pointed out, Dan and 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 that we look at 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 stock, which is the expensive part of a capital structure. And then we announced in the second quarter call that we would start looking at opportunities to do tuck-ins, which we will do tuck-in acquisitions or other acquisitions that will help us grow and aggressively move forward. So, we will continue to do that going forward. Maybe, Tim, I just want to comment on how we kind of view 2020 and 2021 from a number’s perspective.

[Tim Oliver, Chief Financial Officer]

Yes. I think the – we will – we’re likely to see that this quarter play out again. And in the third quarter to the fourth quarters, 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 q3 and actually, in the same place, as I expect the mix to be relatively similar as well. I also expect it will hit a margin rate that’s similar to what we just achieved in this quarter. As you said, the cost actions we took in q2 are 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.

And I think on the cash flow side, Mike, as you said, we’re getting much more linear in the way we conduct their business from the top down from revenue on down through, it’s made a huge difference on cash flow. And the performance we saw in 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 typically very strong q4 cash flow into q3 that will still be – it’ll be positive and demonstrably so.

[Dan Kurnos, The Benchmark Company]

And then just maybe Mike, obviously, they’re – the ATM is understandable, I know that nobody is really spending right now. But I’m just wondering how the conversations are going around ITM kind of future brands closure, where you’re trying to get stuff on paper. Now, are you thinking about that in conjunction with obviously, the strength you’re seeing in digital?

[Mike Hayford, President and Chief Executive Officer]

Great. Yes. I would say that the conversations that we are having across the markets, and it would be the European market Middle East, Australia, here in the U.S., the banking community is focused on the self-service bank platform. And 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 and the use of capital and that has impacted the ATM activity.

To Tim’s comment, we are – we have been seeing $220 million to $250 million range on ATMs. So, 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.

[Operator]

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

[Matt Summerville, 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?

[Owen Sullivan, Chief Operating Officer]

No, we’re not. And I think there’s a couple of things clearly, the market dynamic that we’re seeing, which is more of a contemplated spend on ATM is clearly what we’re hearing from our bank customers. The other thing, which both Tim and Mike touched on is a little bit of a cultural shift that we’re trying to instill here in the company, which is to create more of a predictable quarter-to-quarter level of performance from a revenue standpoint, from a EBITDA performance standpoint, and from a free cash flow perspective.

So, we have tried to instill. let’s not keep pulling things artificially left. you’ll see it even in the way that we have moved our software to – from perpetual to subscription, which has clearly changed behavior at the end of 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 customers 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 the – is more coincidental than anything else.

[Matt Summerville, D.A. Davidson]

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

[Mike Hayford, President and Chief Executive Officer]

Yes. I mean, we – self-checkout or being able to manage your own interaction with effectively self-pick at a store, and then making a shift and we have been seeing that solid, the pandemic crisis, obviously, we think accelerated that and we’ll 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 in 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 now even have the self-checkout device when you do the scanning. So, we think that that is solid. We think that this will given some strength going forward and we certainly saw that in the third quarter. Tim, you wanted to speak to the numbers or?

[Tim Oliver, Chief Financial Officer]

Yes. So, self-checkout accounted for more than all of the growth than the retail business and retail business goes up year-over-year? So, I’d say a bright spot in our quarter. And yes, we are looking forward the order book is strong.

[Operator]

From JPMorgan, we have Paul Chung.

[Paul Chung, JPMorgan]

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

[Mike Hayford, President and Chief Executive Officer]

Yes. I mean, all this generically, every deal maybe a little differently depending on where they’re at and whether it’s just a pure hardware deal. Obviously, when we self-checkout, there’s a piece of software that goes with it. some clients are moving forward with a little bit more comprehensive POS software upgrade, potentially or the ability to be able to manage the delay in self-checkout lane. They referenced before as we’ve gotten into the pandemic, the ability to do more frictionless and to do 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 breakout as you said, what is the average selling price? And what gets dragged along? Because I don’t – I think self-checkout is even more unique, it’s each individual sale versus maybe what we even see it in the ATM market.

[Paul Chung, JPMorgan]

All right. 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, then how quickly can you deploy the solution? And what’s the timing of revenues and earnings potential overtime?

[Mike Hayford, President and Chief Executive Officer]

First Horizon was actually, they are already a D3 client. So, what we announced in the press release is that they actually took and ported, they were running that on-prem in-house, reported that we’re now managing, we’re managing in the cloud, we – that’s an AWS cloud instance, we’re seeing most of the D3 clients wanting to move to the cloud. It gives the flexibility to really scale up rapidly, we need see peak. That’s one of the huge advantages of that product set. And we’re seeing most people, I should say, most recent clients like us and 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 under the D3 platform and then they added some another feature function. So, the First Horizon deals, nice deals, and it’s really an expansion and a shift of a relationship that we’ve had for a number of years.

[Operator]

And our next question comes from Katy Huberty with Morgan Stanley.

[Katy Huberty, 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?

[Tim Oliver, Chief Financial Officer]

No. 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 anyone feel can swing that a percent or two. Right So – 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.

[Katy Huberty, Morgan Stanley]

Thanks, Tim.

[Mike Hayford, President and Chief Executive Officer]

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. A 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 – it’s really a tale of two halves, the bank 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 flow 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 the 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 skills on the floor. So again, we think it’s going to be slightly sequential out from third quarter; but maybe, not the big pop we’ve seen in prior fourth quarters.

[Katy Huberty, Morgan Stanley]

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

[Tim Oliver, Chief Financial Officer]

Yes. Yes, absolutely. So, the cost takeout that we’re working on currently, I would say is more indirect, or associated with our services and software businesses and not necessarily with our production or manufacturing footprint. That’s being planned now and you can imagine we’re going to size our capacity to a level of output on both ATMs and SCO that is more like what we’re seeing now. So that there has to have some costs come out and we expect to get that that over the course of next year.

[Katy Huberty, Morgan Stanley]

Okay. And then lastly, Tim, you mentioned higher reserves in the hospitality business. Can you just talk about where losses are running right now and where the accrual set versus say what you saw in the business in the financial downturn?

[Tim Oliver, Chief Financial Officer]

Yes. We have not seen an increase in the number of defaults. And in fact, we’ve been very pleased with the reserve levels we had in aggregate. We did take a little bit more on specific customer accounts that turn negative. So, these 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.

[Katy Huberty, Morgan Stanley]

That’s great. Thank you.

[Tim Oliver, Chief Financial Officer]

Sure.

[Operator]

Moving on from Oppenheimer, we have Ian Zaffino.

[Ian Zaffino, Oppenheimer]

Hey, great. Thank you. Can I just delve a little bit more into maybe, hospitality and retail? And there’s 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 there may be smaller customers and there may be to do the same exercise for the hospitality business as well? Thanks.

[Mike Hayford, President and Chief Executive Officer]

Yes. I mean, again, kind of go back at a macro level. So, we did a call end of March, I think March 30, we did an update call and shared the mix of our business, because I do believe some look at our business and the mix underneath the covers as a parent. So, we went through retail and we talked about an FD amount or a large grocery store chain, big box chain, versus a 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, it will serve small businesses, they’re going to be a little bit more at risk than quick service restaurants are 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, they’re – your numbers are actually quite of a better than 2019. They’re thriving on dry foods, driving 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 it or get to the volumes to some of those where we’re seeing some of the difficult – that puts us a target quite frankly, all things considered pretty well for us.

Retail, the large players are continuing to buy and you’re seeing that in our retails bank year-over-year. The impact on the small end numbers of SMB and retail, it’s 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 specially some of those customers are doing a really nice job online. They ship to the model online, the model store pickup and did really well, others have not done quite as well. But again, the total numbers of that 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 the company and retails done really well, hospitality, the at-risk is again, similar numbers 6% of our total business as a company and that had a little bit more impact on us going forward from COVID.

[Ian Zaffino, Oppenheimer]

Okay. And then also just turning over to banking, you mentioned sort of the hesitation from the customers, is that driven, just COVID uncertainty, are they seeing a trend somewhere that their customers are acting in a different way that they’re not certain of? Or is it just other parts of the customer’s house that just not…

[Mike Hayford, President and Chief Executive Officer]

Yes. So, the bank loans talk about this. So, the banks – we want to talk about this. So, the banks are on the digital footprint, there are a lot of focus on what you can do in digital bank? And what you can do on a mobile device? What you can do on the internet? not only in our digital banking products, but also our other software products. So that spending has continued to be very strong.

On the ATM side, when we talk to – Owen and I call customers every week, we talk to the bankers about what they’re doing. In the second quarter, they thought some slower transactions that you would imagine in April, but the amount of cash being withdrawn was up year-over-year, the second quarter, the third quarter, they touch index volume coming back. So, they still see the transaction volume forecast depending from an ATM.

Our bread and butter ATM is really the complex, multifunction machine. And what we’re seeing banks look at doing is what are they going to do with their footprint? What are they going to branch and as they might shrink the branch footprint or branch hours, they’re talking about how a multifunction ATM might pick up some of the slack.

So, their feedback we’re getting the mindset, we’re getting is that ATM as part of their strategy, and they actually call part of the digital strategy going forward has not changed at all for the banks. They’re spending in 2020. They’ve held on to the money, they’ve held on to the capital, a little bit more than we thought they would have due to – purely due to COVID.

[Ian Zaffino, Oppenheimer]

Okay, great. Thanks for the color, guys.

[Operator]

And moving on ladies and gentlemen, we have our last question from Charles Nabhan, who is with Wells Fargo.

[Charles Nabhan, Wells Fargo]

Hi, thank you for taking my question. I wanted to ask about the competitive landscape in the hospitality space, some of your – competitors in the space that have had some struggles. And so I was hoping you could comment and maybe, give us some color if on whether you’ve seen inbound interest from some of their clients and whether you’ve been able to gain some markets there in that space?

[Mike Hayford, President and Chief Executive Officer]

Well, so hospitality I’d say again, that market was more impacted than anybody particular 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 to COVID. I’d say we’re really pleased with some of the innovation they’ve done.

In the middle of the pandemic, the team there – our team rolled out an order at table, which is very different than other order at tables instead of just being able to look at them. And you can actually order from your handheld device when you’re an Aloha client with the order at table. And then you can pay at that table with that same device when you’re not done with a meal.

So, those innovations have really made the conversation and the ability to walk into a customer with an existing customer or a new customer and differentiate the capability. The team has looked at the comment that you made around some of our competitors and said we’re going to double down. We’re doing a blitz in a major city this week, we’re putting feet on the street with our local channel whether they’re doing it in virtual or whether they’re actually going around, some restaurants were open and having a conversation.

And so we actually again, it’s a tough business right now, but we actually feel good about where we’re going to come out of the backend of it, adding customers picking new products up with existing clients and just focusing on executing our strategy even in the midst of a pandemic. Owen, your thoughts on that?

[Owen Sullivan, Chief Operating Officer]

Yes. We clearly are seeing quarter-to-quarter the momentum. I think we’re getting validation that, to Mike’s point, our core product, Aloha Essentials is really being well received the notion of being able to go in and offer a total turnkey solution to our customers to do it on a subscription basis.

So, all of those customers, whether they’re working their way through this COVID period, or their new start-ups were minimizing the capital investment upfront by being able to walk in, set them up, put them on a subscription basis. And as Mike talked about, the pace that we have moved our functionality around this contactless commerce, especially in the restaurant is really being viewed as a positive and aggressive response to quite frankly, effort 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. In contrary to that, as Mike said, we’re doubling down on our product investment, our teams out in the field, and we like the early returns that we’re getting.

[Charles Nabhan, Wells Fargo]

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, do you – are there any focal points on that strategy that you could highlight, and relative to where – what you’ve done in the past, where the focus has been point-of-sale and the digital banking space?

[Mike Hayford, President and Chief Executive Officer]

Yes. I would say the general focus is going to be the same. So, we have three different buckets; one is a product focus, product focus on the software side. And we’ve got kind of three significant deals for us. We did D3, we did Zynstra, and we did JetPay, in all those sort of 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 integrated 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 have worked out great weekend, we’ve talked about kind of re-energizing that channel, the organization 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 on for service opportunity, whether the professional service or global break fix services or demand 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 have the same formula. And the team we put them on pause, as we will focus on cash flow, you can see we need a really nice job. our team did a really phenomenal job of managing cash flow through the first three quarters. We feel much, much better about our clarity in the future, word not through COVID. But we look at the world today and say, I think Tim used the word there’s less uncertainty, then 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 lot of portion of our debt that we had put on the balance sheet, just in recognition that we feel much better about the future for our company.

[Operator]

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.

[Mike Hayford, President and Chief Executive Officer]

Thanks. I 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 focusing an execution in a – quite frankly, an unprecedented pandemic. We focused number one and take care of our clients. Owen talked about the ability to take care of our clients and actually be able to add clients. Secondly, we continued to make progress on our strategic calls, we continue to make investment on our strategic products. We continue to make the shift to software and service focused company even during these difficult times. Third, Tim talked about as we improved productivity, we took our costs both on a temporary basis; but then we also took actions that would allow them cost savings to carry forward into 2021 and beyond. Number four, we drove phenomenal cash flow performance for the third quarter. So, we said we’re going to focus on cash flow at the start of the year – I’m sorry, at the start of the pandemic and the team did even better and we could have envisioned on cash flow management.

And then after that, that allowed us to pay down some of the debts that we’re able to deleverage and feel very good about where we sit today, just with less uncertainty in the environment, recognizing that we can operate at this level and not earn cash, but rather generate positive cash flows. That’s a confidence to take down some of our debt.

And then lastly, I just want to remind everybody to please plan on joining us on December 3 for Virtual Investor Day and we will talk more about our strategic call to drive software and services revenue to 80%, recurring revenue to 60% and our EBITDA margins to 20% margin and are 80/60/20 as strategic goal.

So, thank you for joining us today. I thank everybody for participating on our third quarter earnings call.

[Operator]

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