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NCR Corporation (NYSE:NCR)

Q2 2006 Earnings Conference Call

July 27, 2006, 10 am ET

Executives

Gregg Swearingen – IR

Bill Nuti - CEO

Pete Bocian - CFO

Analysts

Richard Farmer - Merrill Lynch

Matt Summerville – Keybanc

Andy McCullough - Credit Suisse

Kartik Mehta - FTN Midwest

Reik Read - Robert Baird

Katie Hubert - Morgan Stanley

Presentation

Operator

Hello and welcome to the NCR Second Quarter Earnings Conference Call. (Operator Instructions) I would like to turn the conference over to the Vice President of Investor Relations, Mr. Gregg Swearingen. Sir, you may begin.

Gregg Swearingen

Thank you very much, and good morning everyone. Thanks for joining us for our 2006 second quarter earnings call. Bill Nuti, NCR's CEO, will lead our conference call this morning. After Bill's remarks, Pete Bocian, NCR's CFO, will discuss our Q2 financial performance.

Our discussion today includes forecasts and other information that are considered forward-looking statements. While these statements reflect our current outlook, they are subject to a number of risks and uncertainties that could cause actual results to vary materially. These risk factors are described in NCR's periodic filings with the SEC and in our annual report to stockholders.

On today's call, we will also be discussing certain non-GAAP financial information, such as free cash flow and results excluding the impact of pension and other non-operational items. Reconciliations of non-GAAP financial results to our reported and forecasted GAAP results and other information concerning such measures are included in our earnings release and are also available on the investor page of NCR's website.

A replay of this conference call will also be available later today on our website at ncr.com. For those listening to the replay of this call, please keep in mind that the information discussed is as of July 27th, 2006 and NCR assumes no obligation to update or revise the information included in this call, whether as a result of new information or future results.

Now I’d like to turn the call over to Bill.

Bill Nuti

Thank you, Gregg and good morning to everybody and thanks for joining us today. I am pleased to report that NCR had a good second quarter with regard to both revenue and earnings growth and I’d like to take a moment to review a few of the key highlights.

First, NCR achieved 4% year-over-year revenue growth in the quarter which was lead by Teradata Data Warehousing, which grew 11%; Financial Self Service with 6% growth and retail store automation which grew 5%.

Customer services delivered better than expected revenue and generated $25 million of operating profit, which is more than three times the profit achieved in the second quarter of 2005. Our year-over-year operating improvement was largely driven by the higher profitability in our customer services and Teradata Data Warehousing businesses.

Before Pete reviews the financial results in greater detail, I'll provide a little color on the business unit results. We’re going to start with Teradata Data Warehousing.

Revenue of $399 million in the quarter was up 11% versus 2005. As expected, Teradata delivered the revenue related to the timing issues that we discussed in Q1. Although Teradata delivered on our revenue commitment for Q2, and we continue to believe the enterprise analytics market remain strong, revenue growth in Q2 could have been a bit higher. However, we see the sales cycle lengthening as customers consider the economic environments when committing capital.

We saw some deals take a little bit longer to consummate in Q2 and saw some rollover into Q3. Given what we saw in Q1 and Q2, as well as other macro economic trends and their impact on enterprise IT spending, we now assume this trend will continue in the second half of 2006.

Teradata operating profit of 86 million improved 13% from Q2 ‘05 and resulted in a 22% operating margin, which puts us on track to achieve the 21% to 22% operating margin targeted for this year. The leverage we saw from higher revenue more than offset our investment in sales and demand creation resources.

We had another good quarter with regard to adding new customers. Teradata added a few marquee manufacturing and insurance customers including Volvo Car Corporation, the Hershey Company, and New China Insurance. Other new customers included Amp’d Mobile, Swisscom Mobile, and Czech Telecom in the communications industry, as well as retailer Whole Foods Market in Banco de la Nacion in Argentina.

Overall we had a strong growth in the financial services, manufacturing, and communications industries. A few of the customers that increased the size and scope of their data warehouses included Barclay’s Bank, Charles Schwab, China Trust Commercial Bank and Siam Commercial Bank in financial services.

In insurance and healthcare, WellPoint, Liberty Mutual, and Medco invested in their Teradata systems. Government customers that expanded their solutions including the United States Postal Service, the Centers for Medicare and Medicaid Services and Poste Italiane. Additional customers who upgraded in the second quarter included DHL Worldwide Express, eBay, Metro and SuperValue. We expect the demand for Teradata Data Warehousing to continue as companies invest in order to better manage and leverage their data.

Companies across multiple industries are investing in enterprise data warehousing to realize the significant cost savings from centralizing data. Beyond the initial ROI, companies are experiencing even higher returns as they invest in technology solutions that give more people and their enterprises active intelligence, or the ability to make informed, better, faster decisions throughout their organization.

If you are interested in learning more about the benefits of enterprise data warehousing, the annual Teradata Partners User Group Conference is taking place September 17-21 in Orlando, Florida. I’d ask you to contact Gregg Swearingen for more information.

Let’s turn our attentions to the financial self service space. The team did a good job driving revenue of $343 million in our ATM business with better than expected 6% growth from the second quarter of 2005. Although we continue to face the effect of price erosion, it appears to be approaching more normalized levels in the U.S. with signs of improvement in some international markets.

Let me be clear on something here. Our ATM team continues to be very disciplined around price, as our focus is to drive profitable growth around the world. We have not seen any material change with regard to the demand drivers for ATMs. Banks in the US are continuing to refine their implementations of NCR deposit automation pilots with a few production rollouts scheduled for the end of this year. We expect more deposit rollouts to continue and progress into 2007 through 2009.

The adoption rate of automated cash deposit continues to grow in EMEA, particularly in Eastern Europe and Turkey. We also had good revenue growth in Asia, particularly in China.

Our continuing challenge in this business relates to profitability. Q2 profitability was down $12 million in our ATM business as we were unable to offset the expected price erosion with sufficient cost reduction.

During the quarter, our team was very busy. One activity that took time and attention was the work necessary to meet the July 1st deadline for the European Union’s restriction on hazardous substances directive known a RoHS. RoHS places restrictions on the use of certain substances such as lead and mercury amongst others, in electrical and electronic equipment. Our significant European presence caused a large portion of our team’s activity to be focused on ensuring RoHS compliance and the continuous supply of parts.

This, along with actions necessary to realign our manufacturing and supply chain initiatives, led to some incremental costs. More importantly, caused personnel to be diverted from cost reduction activities to ensuring parts and products where available to meet customer commitments.

Additionally, our revenue mix shift, which drove stronger demand in Europe meant that our global manufacturing footprint was not optimized. For example, our manufacturing facility in Dundee was operating at full capacity even as production ramped at our new manufacturing plant in Budapest; while we had under absorption at other facilities.

Some of these issues in costs will continue for the next few quarters as increased demand in Europe limits our ability to reduce manufacturing costs at the pace earlier anticipated.

Clearly our operating performance can be better and we are taking steps to improve the profitability of this business. Examples include rationalizing our global manufacturing footprint. For example, we are adding a second production line in Budapest to accelerate the ramp of this new plant to support our growing business in Eastern Europe.

Sourcing modules from and accelerating supply base localization to low-cost regions; and, continuing to implement a lean manufacturing environment that includes a culture that is focused on customer responsiveness, cost, quality, and delivery.

I am actively engaged with the financial self-service team to resolve our supply chain and manufacturing issues. Although it may take another few quarters to see the improvement in the financials, the good news is that we are taking the right actions for the future.

Now, let me turn my attentions to the retail store automation business. The retail industry remains very challenging. Overall, retailers are spending, but cautiously, and at a slower pace. The amount of capital per project is decreasing with smaller individual commitments at a point in time.

With that said, we were pleased with revenue of $221 million, which was up 5% from Q2 2005. Profitability was up $2 million due to higher revenue, but is still a working progress regarding cost improvements. We continue to see strong demand in the self service technology market, driven by our growing customer expectation and desire for the benefits of self-service solutions. We expect about a third of our retail store automation revenue to come from self-service technologies by 2007.

We are pleased with the strong quarter delivered by our customer services team as they continue to execute their multi-year profit improvement plan. The business delivered $25 million of operating income, which compares to $8 million in Q2 2005. Revenue and customer services was flat, which was a better than expected result as the 9% growth in ATM maintenance revenues offset the plan decline in third party revenues. A favorable revenue mix in terms of profitability resulted from an increased services attached rates for NCR logo’d products.

The results in this business continued to show progress. In addition to significant profit improvement, I’d like to point out that this is the first time in the last ten quarters that customer services revenue hasn’t declined on a year-on-year basis. While we expect this trend to continue, the fluctuation of our annuity file value needs to continue to be supported by driving and continuing an improved attached rates on NCR logo’d platforms.

We are pleased with the continued profitability improvement in our customer services business but we still have a lot of work to do here as well, and we need to continue executing our plan. I will now turn the call over to Pete to review the details of our financial results.

Pete Bocian

Thanks Bill, and good morning everyone. Total revenue of $1.53 billion grew 4% year-on-year with minimal impact from currency translation. We reported GAAP net income of $78 million or $0.42 per share versus $0.67 per share reported in Q2 of 2005.

In Q2 of ’05, reported EPS included the benefit of $64 million from the favorable settlement of prior year tax audits, the benefit of $9 million of non-operational items, offset somewhat by $19 million of incremental pension expense associated with an early retirement program in the customer services business.

Excluding these items, NCR generated operational EPS of $0.37 per share in Q2 of 2005. Included in the Q2, ‘06 results was about $6 million of incremental stock-based compensation expense, which equated to roughly $0.02. As anticipated, we had pension expense of $35 million in the quarter versus $52 million in the second quarter of 2005. Again, $19 million of the $52 million was related to the early retirement program last year.

To analyze NCR’s operational performance without the effect of pension and one-time items, please see the supplemental financial schedule on the investor page of our website that reconciles GAAP to non-GAAP results. For the remainder of my comments during today’s call, I will exclude the impact of pension and one-time items on our results.

Our Q3 gross margin was 29.1%, down slightly from 29.5% in the second quarter of 2005. Improved margins in our customer service and Teradata Data Warehousing businesses were offset by lower gross margins in the financial self-service business.

NCR’s expenses were down almost a percentage point versus the prior year quarter to 20% of revenue. To put this in a perspective, that’s down 5.5 percentage points since the second quarter of 2002 when we began preparing for the restructuring.

Total company non-pension operating income or NPOI was a $138 million or 9% of revenue for the quarter, which was about $19 million better than Q2 of 2005 after adjusting for the $6 million of expense related to stock-based compensation, that was not included in the 2005 financials.

Below the operating income line, we reported other expense of $1 million, compared to $6 million of other income in Q2 of ‘05. The second quarter of 2005 included a $15 million gain from the sale of real estate, $6 million of which was used to invest in the community through funding NCR's charitable foundation.

Our tax rate in Q2 was 23%, slightly higher than the 22% expected due to our profitability mix by country in the quarter. Our tax rate for the first half of the year was 22% consistent with what we expect for the full year.

Turning to the balance sheet, during the quarter we continued our systematic share repurchase program buying back 2.5 million shares for approximately $98 million outpacing the 788,000 options exercised in the quarter. We now have about $353 million of Board authorization available for future share repurchases.

Moving to the cash flow statement. As we discussed in our first quarter 10-Q we began using a new accounting approach in Q2 for re-workable service parts, moving from a long term depreciable asset to a current asset within inventories. We implemented this new method to increase the focus and enable customer services to better manage the cost of parts. This more active approach to parts management includes improved usage analysis of parts, increased efficiency in moving parts between locations, and better forecasting of purchasing requirements.

In addition, we believe this new method of accounting for service parts is preferable because it’s more closely aligned to the accounting with the management and use of service parts.

As a result of this change, expenditures for re-workable service parts previously included in capital expenditures are now included in cash providing by operating activities. In previous periods, expenditures for re-workable service parts were included in investing activities. We have retroactively applied this new method to the prior period financial statements. This change does not impact free cash flow or NCR’s overall cash flows or have a material impact on the Company’s results of operations or financial position. Going forward, NCR defines free cash flow as cash flow from operations less capital expenditures for property, plants, and equipment and additions to capitalized software.

In the second quarter using this new approach, NCR generated a $134 million of cash from operating activity versus generating a $171 million in Q2 of 2005. After using $47 million for capital expenditures, we generated $87 million of free cash flow which compares to $133 million of free cash flow in Q2 of ‘05. Higher revenues and the timing of transactions as well as a moderate increase in capital expenditures impacted the year-over-year comparison.

Again, the accounting change had no impact on free cash flow just on how money is used for re-workable service parts are classified in the calculation to determine free cash flow. As a note, in Q2 of 2006 $21 million was used for re-workable service parts compared to $24 million in Q2 of ‘05. $47 million was used in the first half of 2006 versus $43 million used in the first half of 2005. Year-to-date we’ve generated $64 million of free cash flow and we continue to expect about $310 million to $320 million of free cash flow in 2006.

Now, I’d like to update our full year guidance. Although the following changes don’t affect NCR’s overall EPS guidance, we are increasing our guidance for full year revenue growth from flat to 1% growth, largely due to currency. Our guidance for Teradata data warehouse growth is 5% to 7%. However, given the uncertainty of the economic environment, our full year forecast and EPS guidance are based on Teradata revenue growth at the lower end of the range.

We are increasing our financial self-service revenue projection to 1% to 2% growth from our previous guidance of flat revenue versus 2005 as we expect to benefit from the effective foreign exchange in the second half of the year.

Finally, customer services revenue should now be down only 2% versus prior guidance of customer service revenue being down 3% to 4%. As service revenue from NCR logo’d products is growing faster than expected and we are getting some favorable impact from currency.

Turning to operating margin. We are not changing our view of NPOI margin for the total Company for 2006 but we are increasing the NPOI margin for customer services to about 5% from previous guidance of 4% to 4.5%; and we are moderating our expectation for financial self-service margin from the mid-teens to the 12% to 13% range.

As we look to the reminder of the year, we expect currency fluctuations to have a negative impact on our pension expense. Including the adjustments for currency translation and the $9 million associated with the Q1 early retirement program, we now expect total pension expense to be $155 million in 2006 or a $146 million excluding the early retirement program, up from $140 million of pension expense when we began the year.

We continue to expect the impact of incremental stock-based compensation to be about a negative 40 to 50 basis points of operating margin for each segment and overall an impact of $0.10 on full year EPS. Including the incremental non-cash early retirement pension expense, we continue to expect GAAP EPS of $1.81 to $1.86; excluding the early retirement expense from Q1 we continue to expect earnings per share of a $1.85 to $1.90 per share.

Earnings per share in the third quarter is expected to be roughly the same as generated in the second quarter of 2006.

In addition to the lower ATM margin expectations that we just discussed, if you look at it sequentially from Q2 we will also become more aggressive in our investments in sales and demand creation in Teradata; we will see higher quarterly pension expense and NCR will have its typical cost associated with the Teradata user group conference in Q3.

Again just to be clear, we are not changing our guidance for the full year. But, we did want to give color on the calendarization of the results between Q3 and Q4. Now, let me turn the call back over to Bill.

Bill Nuti

Thanks, Pete. While our Q2 results were positive, we are seeing signs that the US economy may be softening, which can have an effect on capital spending and customer buying behavior. Giving this dynamic, our Phase II cost reduction plan will play a more critical role to improve NCR’s global competitiveness, product quality, and customer satisfaction.

This work is especially important in our ATM and retail businesses as we work to improve what I consider unacceptable margin in those areas. Specifically, we are focused on supply chain and manufacturing consolidation, including improved procurement scale and the introduction of more efficient processes, reducing redundancies in our quote to cash roles for instance. In the service order management area, implementation coordination, and order acceptance roles.

Customer services delivery consolidation including dramatic improvements of our parts and logistics capability, as well as scaling our delivery infrastructure to much higher levels of productivity and customer satisfaction. And, enterprise productivity including improving the efficiency of our order-to-cash processes and field sales productivity.

We remain cautiously optimistic about our businesses but must also factor in macro-economic conditions and the geopolitical and climate and their potential impact on the IT capital spending environment. These changes we've discussed in our guidance anticipate a tougher environment with longer sales cycles in the second half of the year.

That said, we see 2006 as a year in which we expect to capture at least our fair share of business in each of our segments and deliver a solid earnings result for our shareholders, while we are making the proper investments for future growth and improved profitability.

Now, let me turn the call back over to the operator for Q&A.

Question-and-Answer Session

Operator

Our first question comes from Richard Farmer - Merrill Lynch.

Richard Farmer - Merrill Lynch

Thank you. Bill and Pete, I would like to ask a few questions please. Starting just with a reconciliation of some of your comments on the demand environment, Bill, you mentioned the lengthening sales cycles and some of the slowness in the macro environment that you think will persist in the second half. You did though raise your revenue guidance slightly; I guess mostly on currency.

Pete, you mentioned you are now expecting lower end of the range in Teradata so I am just trying to net all this together. How much incrementally are you concerned about your ability to hit the Teradata growth targets for the second half for the year? When you look at the Teradata pipeline, how healthy do you think that is?

Bill Nuti

Sure Richard. First of all thanks for the question. I would say a couple of things. First, we did but we said we were going to do in the second quarter vis-à-vis Teradata. But if you look at where we are, the churn we are about 2% up year on year, and so if you look at the second half, the second half has to be quite a robust growth half for Teradata. While the performance forecast it looks good, we’ve got to take into consideration some of the things.

If you look at Q2, while we did what we said we were going to do, there was actually a little bit of business – we could have done better. My view is we could have done a little bit better in Q2. Some of the deals moved into Q3 as well; and I think activity in the pipeline is actually quite good. I mean I saw activity levels improve dramatically in the last few months and the pipeline is getting a little bit better.

My general concern just remains what’s going to happen economically and will IT spending get pulled back and in fact will the sales cycle lengthen? So, we’re being I think appropriately cautious and also expecting a pretty good second half from Teradata in light of where we finished the first half. Pete.

Pete Bocian

I think that’s really the way I would bridge it as well as, we delivered the Q2. That said, we’ve grown 2% year to date. What I said in my comments was our forecast and our EPS guidance is built towards the lower end of the 5% to 7% for Teradata, yet when you look at the number of customers we talked about, activity is strong. So, I think that’s the way I would calibrate the Teradata.

On the self service side, with much more of a European business and international business, I would characterize it as more currency in terms of the increase, though we do feel good about the Q2 order activity as we looked forward. So, that’s the way I characterize currency movement, where we are at the turn across the two major businesses.

Richard Farmer - Merrill Lynch

Thank you, while we are talking about Teradata, Bill I would like to ask you a more strategic question about the structure of the Company. In the long run and is there any reason why Teradata shouldn’t be a separate entity from the NCR parent company? Couldn’t it benefit as an independent entity from more focused, maybe a higher valuation? Aren’t there fairly limited synergies with the rest of NCR?

Bill Nuti

Richard, we are really focused on the strategy of the business today. I mean as a Company we are really focused on what we have to do to built a better NCR and included in that, Teradata. We are making significant investments in Teradata this year, we’ve hired several 100 people in Teradata this year, some of which have been in the demand and creation headcount category and other areas like professional services and R&D; so we are making good investments.

The business seems to be running very, very well. As I said earlier, activity in the pipeline have improved somewhat and we were very comfortable with the way the Company performed here in the second quarter.

We still need to continue to keep our foot on the gas internally as well with regard to finishing what we said we were going to start in 2003, continue the phase II cost reduction program for NCR. In doing so, I feel pretty strongly we’re going to deliver great returns to the shareholders over the long term as long as we execute. I think that’s really the key right now. So we are keeping the boat steady on the strategy that we have been communicating to you for sometime.

Richard Farmer - Merrill Lynch

Okay. So, longer term then, you are not particularly focused on potential strategic or structural changes?

Bill Nuti

I think, Richard, we are comfortable with the current company strategy as it is right now.

Richard Farmer - Merrill Lynch

Just separately on the ATM business, the margins here are slowing down despite the better pricing that you mentioned. You mentioned the RoHS and the European mix. What is the timing of when we can expect margins in that business begin to improve and go in the right direction?

In revenue, things were significantly better than I think most people were modeling on the top line for the ATM business. What do you think is the sustainability of that improvement going into the second half of next year? Thanks.

Bill Nuti

I think first of all we did beat our expectations on the top line for the quarter and then saw good orders so we are optimistic about the volume for the year; it got some help from currency. The second point is around the price in general; price erosion in general is stabilizing, moderating versus what we had seen last year, that’s positive.

So, when we look at it, the margin hit is really around the transition of supply chain, the environmental RoHS area that Bill mentioned. I expect we’ll sequentially improve as we go through the balance of the year versus the Q2 environment.

Then, we’ll re-calibrate based on accelerated activities in Budapest at the end of the year about what we expect for 2007. But we will get improvement, this is probably characterized as low points in margin, but it will take, as Bill described, a few quarters and therefore we expect the impact to the year will still be there, with only two quarters left.

Bill Nuti

Just one other comment related to demand, the demand environment – and of course we were pleased with the revenue growth as well in Q2. In terms of that going forward, there are a few key drivers, one of course is deposit and the customer acceptance of deposit solutions in the market. We continue to work with several customers around the world on pilots.

The second thing I would say as well is, with regard to demand, mix is going to feature importantly on the margin side Richard. International mix is at somewhat lower margin than would be a North American mix and so, we’ve really got to stay focused on growth yes; but profitable growth.

In some of the international markets where we play while the price environment has improved, there is still some very aggressive pricing going in some emerging markets and we’re going to make conscious decisions as to whether or not we want to play or not in some of those opportunities.

So, if the international market stays as robust as it has been, particularly Europe and Asia for us, we just need to be smart about staying focused on making sure the opportunities we work on and we participate in are going to be profitable for the company.

Richard Farmer - Merrill Lynch

Thank you.

Bill Nuti

Thanks Richard.

Pete Bocian

Thank you Richard.

Operator

Thank you. And our next question comes from Matt Summerville - Keybanc.

Matt Summerville - Keybanc

Good morning. First just on Teradata, can you talk about, if there are specific verticals where you seeing the sales cycle lengthen slightly? And then whether there are any verticals you’re actually seeing it shorten?

Bill, can you comment or throw some numbers around the sales force additions you are making to that organization in ’06? When will we start to see that pay back show up on the top line? Then the expense associated with that abate on the bottom line?

Bill Nuti

If you look at some of the industries where -- and I’ll just comment on sales cycles -- of course the retail industry is where you’ll see some of the IT spending issues pop up first, given the environment in retail and potentially some of the sales cycles lengthening somewhat.

We are seeing that as well; in our own numbers if you look year-over-year. What is interesting on the flip side where I think we expected it to be a little bit more difficult because of consolidation was communications, media, and entertainment where actually we are doing a little bit better year on year, the team has really executed very well in that vertical.

We would have expected because of all of the consolidation going on the US and some of the changes taking place in large customers overseas that would have been a bit more challenging.

Financial services is going well and generally speaking, not a lot in the way of issues we are facing there. Travel and transportation has been a bit challenged, manufacturing is holding its own, government is doing better for NCR in general. So, I think really where the challenges lie with potential IT spending and the sales cycles lengthening is in the retail space.

We still have a keen eye on communications, Matt, because, you know, with consolidation still ruling the day, sometimes when you have organizational changes at the rate we are seeing them in communications new CIOs coming in, new decisions coming in and can certainly lengthen sales cycles.

Then in terms of headcount, we don't give specific data on demand creation headcount, but we have added several hundred people on the first six months of the year to Teradata and they've been across sales, professional services, and R&D for the most part.

Matt Summerville - Keybanc

The tail-end of that question was, when do you start to see the payback from these investments and then when do you anticipate the peak level of investment occurring so we can think about when the cost associated with what you are doing today starts to abate?

Pete Bocian

I think we've talked about before that, it is a complex high-dollar solution, there is some ramp so a quick answer is somebody added on July 1st is probably going to start getting funnel activity in a year, but deliver next year. So, not a lot of impact from the balance of year additions, and then we’ll look at where we are at in January and kind of calibrate. The answer is we are investing and as we talked about before, demand creation is a combination of the sales, account manager type; but it’s also as you get into these new verticals you’ve got to have the industry consulting expertise, you’ve got to have the professional services consultant.

So, we are investing across all those fronts with the idea to continue to deliver growth and then we’ll recalibrate in January on our expectations for ’07.

Matt Summerville - Keybanc

Okay, moving over to ATMs, absent the costs associated with this environmental thing you were mentioning in Europe and the manufacturing transitions, do you have any idea what your margins would have been in the second quarter? When does that second line in Hungary start to come online and contribute?

Pete Bocian

Right, we’re not going to bridge every cost. I think the key point from Bill’s message was the RoHS was significant, so I think our team did a nice job; but it was a lot of work, so I don’t know whether you’ve heard that from other companies. But given our significant European presence, given the fact that we manufacture in the ATM business, I think it’s safe to say a significant effort. We did well, and it did divert us from the, let’s call the typical cost take-out activity.

So, I am not going to build the bridge, described it as, we had more things distracting in Q2 then we’ll have in Q3; and then we are working to move faster on Budapest given that we are seeing more activity in Europe.

Bill Nuti

On Budapest, Matt, we’ll probably ramp the volume in Budapest this year up to 8,000 to 9,000 units which is substantial. We have a lot of work to do to get there, but I think the team can get there, and we’re actually starting a second production line in Budapest which will increase our future capacity going into ’07.

Matt Summerville - Keybanc

So, the second line is not contemplated in that 8,000 to 9,000 units?

Bill Nuti

No, it is not.

Matt Summerville - Keybanc

Okay, was 8,000 to 9,000 your original plan for the year?

Bill Nuti

No, we actually thought we were going to be able to produce a little bit lower there, Matt.

Matt Summerville - Keybanc

So, overall it’s pretty clear then you think the sustainability in the EMEA region in terms of demand overall, that is definitely there at this point?

Bill Nuti

I think that is a very fair characterization. We saw strong growth in both quarters and revenue there. We also today saw some pretty good performance out of [Wincor]. So, while I am pleased with our performance, you know, I’d like to see our team get a better share of the market over the long term, so we are turning up the screws on that side of things as well.

Matt Summerville - Keybanc

Can you talk a little bit about the retail business in terms of some of the more recent successes you’ve been having in self-service and what kind of growth you except out of that pieces of business this year?

Bill Nuti

I mean self-service will achieve double-digit growth this year for us, we believe in the other self-service segments outside of ATMs. We are seeing good order growth and good revenue growth in the area of self-checkout; we are more challenged in the kiosk area, and we’ve got a little bit of work to do there but generally speaking across a broad spectrum of our products with self-checkout leading the way, the team is executing well and we think we can hold onto the double-digit forecast we’ve given you.

Matt Summerville - Keybanc

Okay, great thanks.

Bill Nuti

Great, thank you.

Pete Bocian

Thanks.

Operator

Thank you. Our next question comes from Andy McCullough - Credit Suisse.

Andy McCullough - Credit Suisse

In the Teradata business, can you give us a sense for what the revenue mix looks like between existing and new customers? When you are talking about sales cycles lengthening, is that both in the install base as well as in new environments?

Bill Nuti

We don’t give specific mix between install base and new, but what I can tell you, Andrew, is that we had a good quarter in terms of new customer traction and we are ahead in 2006 in new customers wins in the global 3000 from where we were in the first half of last year. So, the team had a good second quarter in new customer wins. All told, we are ahead of last year at this point and we are pleased about that.

In terms of the sales cycle lengthening, again this is very much linked back to what happens when CIOs and CEOs see macro-economic trends like we have seen in the last several months; and do they put the brakes on capital spending? And if they do, do they take more time, for example to analyze the sales cycle? Do they maybe make the capital spending they originally intended a bit smaller?

Whether it’s an installed base customer who is going to add to their data warehouse or a new customer considering it, either can have that effect in that particular case. Again that being said, if you take a look at where we finished the first half and where we are guiding you for the second, the team does have a fairly robust forecast for the second half of the year.

Andy McCullough - Credit Suisse

Okay, and then on the customer services business, the comments you made suggest that the declines have started to level off and we should start to see growth in services from there?

Pete Bocian

Yeah, I think as we enter the year, we had taken significant third-party reductions in revenue, plant, over the last couple of years. As Bill mentioned, this is first quarter in ten quarters where we actually were flat in customer services revenues with a growing NCR content.

So, I would say in general within a slight range we should be able to match last year going forward, and then expect to, again grow the business through better attach and through putting more units out in the marketplace from here on out.

Andy McCullough - Credit Suisse

Okay, thanks.

Operator

Thank you. Our next question is from Kartik Mehta of FTN Midwest.

Kartik Mehta - FTN Midwest

Good morning.

Bill Nuti

Good morning.

Kartik Mehta - FTN Midwest

Question on Teradata for you Bill. As you look at that business, are there many cross sales between Teradata and ATM and retail, or is Teradata standing on its own when it makes the sales?

Bill Nuti

For the most part you’ll find Teradata standing on its own making sales. However, there are instances in financial self service and also in retail where the two teams together are providing a solution. For example in banks, it may be about providing a personalization application at the ATM where you walk up to an ATM and you flash your card or you swipe your card and it knows who you are, it knows what you typically do in terms of cash dispense, it has more information about you because it’s connected to a back end data warehouse system. There are some circumstances like that. For the most part, it is largely a stand alone sale for both divisions.

Kartik Mehta - FTN Midwest

So, I guess what I am trying to get here is, if you ever did decide to separate the companies, it would not be a case where you said, Teradata would be negatively impacted because it’s now a standalone company and it doesn’t have the support of the retail or the financial self service business?

Bill Nuti

Possibly.

Kartik Mehta - FTN Midwest

Thoughts on the ATM side: you’ve talked a little bit about it, image-enable ATMs with roll outs happening this year and next year. When would you anticipate that you might see some significant sales? Are there enough sales where it would make an impact to the top line and bottom line for that particular segment?

Bill Nuti

The back end continues to be the bigger issue in terms of applications in the data center, in terms of image-enabled capability. The front end side of things where we work and some of our competitors work is going fairly well; however, like any new technology that you bring to market you work very hard and costs upfront continue to be a little bit higher in terms of perfecting the technology implementation.

I would expect over the next three years, you will see a balanced implementation of deposit across banks. Interestingly, I think you’ll see deposit automation happen in the smaller banks first, they have less legacy infrastructure to deal with, they have less of a challenge because of size and scale. Overall, however, I would think you will see the beginnings of a more robust positive environment in late ‘07.

Kartik Mehta - FTN Midwest

So, would it be fair to say, the implementation is not being held back by anything on the front end? Performance of the machines, on the front end it is not holding anything back; but rather, what banks have to get comfortable with and trying to upgrade their back end systems?

Bill Nuti

It’s more back end oriented. We in the industry of course are working through our own challenges at the front end, but to put this into perspective -- and I meet with a lot of customers, particularly customers on deposits -- you’ve got back end systems integration going on, you have business process changes inside of banks in terms of how checks are handled; moving from electromechanical and a process that’s been in place for 30 or 40 years to now a digitization of checks; and so there are business process changes.

There is also customer habitual changes, how customers actually use the device. We’ve had many instances where customers are learning how to use the new deposit capable ATM machines out there and causing some difficulties and challenges as well.

That doesn’t mean we don’t have our own issues that we have to go fix in the industry; we certainly do. I think to characterize us as the front end of being a bigger part of the problem as those other things would be misleading.

Kartik Mehta - FTN Midwest

Thank you very much, Bill.

Bill Nuti

Thank you Kartik, take care.

Operator

Our next question is from Reik Read of Robert Baird & Co.

Reik Read - Robert Baird

Hi, good morning. Just going back to the ATM space, it sounds like from what you guys are saying is that Europe is very strong, China sounds like it’s becoming stronger. It sounds like those are areas that are may be beating your expectations. Can you talk a little bit about what you are seeing there and why? What are you seeing within the North American environment as well?

Bill Nuti

In Europe, the bigger drivers in Western Europe are along the lines of the replacement cycle. However, I would say Eastern Europe and Middle East and Africa are growth environments for us, net new growth environments. There is more robust growth in Eastern Europe than in Middle Eastern and Africa; and in Western Europe, although Western Europe has picked up a bit.

China, we had a solid Q2, one quarter does not a trend make and I’m expecting very big things from that team over the course of the next several quarters. We have a lot of work to do here as well. In Asia in general, there are markets where again, as I mentioned before, our real focus is on profitability and there are certain particular markets and certain particular transactions that look attractive in terms of revenue but not enough in profits, so we are still making conscious choices about what we want to participate in and what we don’t want to participate in.

North America was very, very strong in 2005 and so the compares year-on-year are more difficult. So I would say that while North America is down year-on-year in general, it is an environment that will also be the first one to pick up when deposits actually begins to go in a more aggressive way. So, that would be my characterization of the markets. Any other comments, Pete on that?

Pete Bocian

No, I think that’s good.

Reik Read - Robert Baird

So, I guess what I am hearing you say Bill as that, that those international markets where you have really started to show better signs than the North American market still remains a bit tepid?

Bill Nuti

I think that’s fair, I think that’s a good characterization.

Reik Read - Robert Baird

Just with respect to manufacturing and supply chain issues, can you give us a little bit of commentary in terms of the alignment and what have you, is there an issue that caught you off-guard from an external standpoint, or were there some internal execution issues, how would you characterize that?

Bill Nuti

As we said earlier, I think the one thing that really we had to overcome in the quarter was RoHS, and RoHS compliance. A lot of our people in procurement, in manufacturing operations and otherwise, their attentions were diverted away from cost savings and onto making sure we had the appropriate supplies from our suppliers who are also dealing with RoHS compliance; to make sure that we were able to drive the business in the quarter, that would be point 1.

Point 2, we are continuing our Phase II cost take out program and manufacturing operations alignment and therefore we have some incremental costs associated with that, the booting up of Budapest is a good example there.

The mix was the other issue for us in the quarter, just the mix of where business was coming from. We had a larger mix in Europe, a larger mix in Asia and we were full steam in Dundee, full steam in Budapest and we had under absorption in some of our other plants, that was an issue as well.

I would not yet characterize this as any internal execution issues because the team is actually doing a good job in getting phase II off on the right foot, but we have many quarters to go before we can declare a victory, that what we are doing now will drive substantial benefit to the margin.

Pete Bocian

Against our expectations probably a couple of points in terms of what we might have expected going in and then the mix changed, trying to estimate what the cost of the environmental compliance is, et cetera. That’s the range within the quarter of what we might have entered the quarter thinking versus how we showed up.

Reik Read - Robert Baird

Okay. But in terms of the plants and the over-absorption that you faced, I am taking it from your comments that the European demand was better and maybe North American demand wasn’t quite as good as North America planned, so it would be under-absorbed?

Pete Bocian

That’s a fair statement.

Reik Read - Robert Baird

Just with the RoHS, the component cost that are out there continued to be fairly high, because they are in high demand and they are not as readily available. Is that something that you see affecting you into the third, maybe into the fourth quarter at this point? I understand the engineering issues are gone, but the procurement of the components?

Bill Nuti

Yes, and that’s what we baked into the forecast itself and we will continue to deal with RoHS compliance issues in the supply chain here in Q3 and most likely into Q4 as well.

Reik Read - Robert Baird

Just one follow-up question on Teradata, it looked like the contribution margin was in the mid-20 type range. Pete, I took from your comments that more of these investments would maybe kick in the second half. Does that suggest that that contribution margin ought to take a step backward as you get into the third and the fourth quarter?

Pete Bocian

No, I think Q2 we delivered the 22% op margins and we had sizable incremental investment year-on-year. We are just going to add more in Q3, and so when I built the sequential bridge, we’ll spend more than Q2, but Q2 at 22% had a good amount of investment.

Reik Read - Robert Baird

Okay, great. Thank you very much.

Pete Bocian

Thank you.

Operator

Thank you. And so, it looks like we have time for one more question. That would be from Katie Hubert - Morgan Stanley.

Katie Hubert - Morgan Stanley

Just going back to RoHS, beyond some of the costs and focus issues that you ran into in the quarter, did you see any push-out of actual shipments into early July? Because we’ve heard that from other companies.

Bill Nuti

Yes, we have. We did see a little bit of that. Well, I am unhappy with our margin performance and that’s an area where we will focus, I have to give the team credit for the work they did during the quarter to actually get the revenue out the door as well. Because you are right, RoHS has caused us and other companies some difficulties in that area, and there was a little bit of revenue that did slip into Q3.

Katie Hubert - Morgan Stanley

Do you feel like at this point you have your arms around, what slipped and that that revenue has been shipped at this point?

Bill Nuti

Yes.

Katie Hubert - Morgan Stanley

Just to follow on the ATM business and gross margins, I understand the mix impact and manufacturing constraints, but are you also seeing a revenue and gross margin mix impact from the differential in growth rates between the US and non-US? In other words, even after you fix some of the manufacturing capacity issues, do you feel like underlying that there is mix impact on the gross margin line as you get more growth outside of the US?

Bill Nuti

I mean the different geographies and even within a geography have different gross margin profiles. Certainly, we expect as a deposit kicks in, in the US market in ’07, it’s a better margin profile for us.

China is good for us internationally, for example versus in India. So, I’d say overall there are puts and takes relative to that, but I characterize the Q2 margin story as really around the cost, a little bit of mix. But there were ups and downs across the geographies.

Katie Hubert - Morgan Stanley

Okay, great. Thanks guys.

Bill Nuti

Thank you Katie.

Gregg Swearingen

I want to just say thank you to all of you for joining us on the call today and just a reminder, if you are interested in joining us at the Teradata Partners Conference in September from the 17-21, just get in touch with me and I’ll get you details. Hope you have a good day. Take care.

Operator

This concludes today’s conference. We thank you for your participation.

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Source: NCR Corporation Q2 2006 Earnings Conference Call Transcript (NCR)
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