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Executives

Tracy H. Krumme - Vice President of Investor Relations

William R. Nuti - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

John G. Bruno - Chief Technology Officer and Executive Vice President of Corporate Development

Peter A. Leav - Executive Vice President and President of Industry & Field Operations

Robert P. Fishman - Chief Financial Officer, Chief Accounting Officer and Senior Vice President

Analysts

Paul Coster - JP Morgan Chase & Co, Research Division

Meghna Ladha - Susquehanna Financial Group, LLLP, Research Division

Kathryn L. Huberty - Morgan Stanley, Research Division

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division

Kartik Mehta - Northcoast Research

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

NCR (NCR) Q3 2013 Earnings Call October 24, 2013 4:30 PM ET

Operator

Good day, and welcome to the NCR Corporation Third Quarter Fiscal Year 2013 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Tracy Krumme, Vice President of Investor Relations. Please go ahead, ma'am.

Tracy H. Krumme

Thank you. Good afternoon, and thank you for joining our Third Quarter 2013 Earnings Call. Joining me on the call today are Bill Nuti, Chairman and Chief Executive Officer; John Bruno, Executive Vice President and Chief Technology Officer; Peter Leav, EVP and President, Industry and Field Operation; and Bob Fishman, Chief Financial Officer.

Our presentations and discussions today includes forecasts and other information that are considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. While these statements reflect our current outlook, expectations and beliefs, they are subject to a number of risks and uncertainties that could cause actual results to vary materially. These risks and uncertainties are described in our earnings release and in our periodic filings with the SEC, including our annual report to stockholders.

On today's call, we will be referring to a presentation posted on our website. We will also be discussing certain non-GAAP financial information, such as free cash flow and results excluding the impact of pension and other items. Reconciliations of these non-GAAP financial measures 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 section of NCR's website. A replay of this conference call will be available later today on our website, ncr.com.

For those listening to the replay, please keep in mind that the information discussed is as of October 24, 2013 and NCR assumes no obligation to update or revise the information included in this call, whether as a result of new information or future events.

With that, I would now like to turn the call over to Bill.

William R. Nuti

Thank you, Tracy, and good afternoon to all of you. I'm on Slide 2. And I'd like to kick off today's discussion first with regard to strategic execution that I think is equally adding to tactical results or operational execution along the way.

Software revenues were up close to 40% and the quarter for us was just about shy of $200 million in the quarter on software and we will meet our software guidance this year that we've given you of somewhere between $725 million and $775 million in software revenue, so on track there. It was a good quarter on software, very balanced, by the way, across all lines of businesses. In a moment, I'll have John Bruno take you through some of the particulars vis-à-vis each line of business and how they performed and you'll see that the balance of our software revenues had improved and, in my view, were getting a bit better, across all of the industries.

Services continues to be a key driver for us. It was up 12% year-on-year. Our professional services is up significantly, well above that. And that's attributed to a software business growing as dramatically as it is for us across all lines of businesses. And what we're seeing as well, that we're keeping an eye on, Bob and I look at consistently as recurring revenues and making sure that the recurring revenue year-on-year is growing, in particular, in the high margin spaces.

When you think about our strategy as a company, 1 of the areas that we're very focused on is diversity. Diversity of revenue by geography and by industry and making sure that we're delivering long-term, sustainable and balanced growth.

In this current quarter, we did see good results from hospitality and retail on the top line, again, led by software and services. However, I was pleased with Financial Services' operating income margins. They expanded quite well in the quarter. As a result, they are also of software and services a better overall mix of revenue. And we continue to see some of our new technologies, like branch transformation, move in the right direction in the quarter. We'll talk more about that in John's section and, also, I'm sure, in Q&A.

And Retalix continues to go in a good direction in Q3. We saw a good quarter out of Retalix and they were meaningful to our results in the quarter. Along the way, we are also focused on our legacy issues. Bob will talk about pension Phase III, but a lot took place in the quarter along those lines and we'll update you as to where we are. And of course, we continue to work on productivity, quality, efficiency programs as well.

Moving on to the next slide, Slide 4. Here are the stats or the metrics on the quarter. Revenue, up 5%, quite balanced across all major geographies. I'm very pleased with the expansion of our margins, again, driven by software. And for us, we're not record builders, but we do look at records and are very proud of the fact that this is the first time in our history that we've hit an NPOI margin in the quarter of over 12%, with NPOI up 21% year-on-year. And you'll hear from Bob, as well, we're reaffirming our guidance for the year.

Let me also now throw it over to John. John Bruno will give you some particulars by line of business. John?

John G. Bruno

Thanks, Bill. I'm moving on Slide 5 and we put here a series of areas of our performance against our key developments in each of the industries we focus on. What I thought I would do is give you a little bit of color behind some of the numbers and some of the text.

So first, let me start with Financial Services. Although our Q3 orders improved, sustaining growth in Q4 is very important to us in maintaining momentum. And we're very pleased with the better mix of business in Q3 and entered Q4 with a stronger backlog position from an overall mix perspective, demonstrating traction against our areas of strategic focus, in particular, software and branch transformation. From a software perspective, we're up 10% on a software growth basis and 8% on SaaS. And from a branch transformation perspective, we had a really good mix of segments from Tier 1 on down to smaller banks and across geographies, showing interest in this growing area. The North American majors and mid-majors remain a challenge for us. And as Bill mentioned on the Q2 call, the key metric for us is Q4 orders and we're gaining confidence in the businesses there and we'll deliver year-over-year growth of orders based on the funnel activity that we've seen thus far.

From an emerging markets perspective, in Financial Services, I'd summarize it and say we're very pleased with our growth outside of North America, in particular, China, with 12% revenue growth year-on-year and India delivering 72% growth year-on-year.

If I turn to Retail business. This is a business that we permanently transformed through the acquisitions of Radiant and Retalix and I'll provide you a brief Retalix acquisition update in a moment. But we're demonstrating that our decision to be acquisitive in this space is paying off. You can see the effect of Retalix acquisition in our Q3 results, as we've improved the mix and profit in our retail business and we've compensated for a flat quarter Retail business on a constant currency basis. The software growth is 124% revenue growth, 252% of that being SaaS. And if you take Retalix out of that mix, it's still 23% software growth and 89% SaaS.

So despite being pleased with our strategic execution, we do remain focused on the core of our Retail business, both point-of-sale and self-checkout. We're encouraged with the progress we're making and customer interest and wins both existing and new in our innovative platforms. Unfortunately, we can't publicly discuss these sizable recent wins, but what I can say is our customers are validating the competitive differentiation we've created. And these, plus solid acquisition integrations, are core to our strategic execution. And it is always about execution. We exited Q3 with double-digit backlog growth, positioning us well for Q4. But we're not pleased with our revenue conversion for the quarter and that's an area of focus for us, as we continue to drive this business.

If I turn to Hospitality. We've experienced terrific revenue growth in Q3 and we're experiencing market share growth in Hospitality and SMB, small to medium businesses, through expansion as well as through investment as we strengthen our business market by market. In that business, you can see on the numbers that we do continue to invest with expenses up 25%, having a slight impact on operating margin rate, but our overall operating margin dollars grew and we feel very good about the additional investments to establish a platform and growth in this business.

As I look at the emerging businesses overall, Q3 was a pretty good quarter, as we're normalizing through regrettable loss a year ago in our Telecom and Technology business. Our T&T team has done a good job diversifying this business and building a pipeline of business. We can see a growing face of customers and a set of managed services growing in this space for NCR going forward. And T&T is our most profitable business, so progress here has an impact overall and it's larger than its revenue contribution and we're confident that this will allow us ability to return to revenue growth based on the signs that we've seen thus far in the activities the team is working on.

Travel remains smaller, but continues to grow nicely as the team remains focused on ancillary revenue generating software and hardware solutions for the airlines, as well as going after broader technology and service offers for larger airport authorities.

So now, what I'd like to do is turn your attention to Slide 6 and update you on the acquisition integration of Retalix. We'll break it down quantitatively and qualitatively. So quantitatively, we're pleased. We expect approximately $5 million to $10 million of pre-tax cost synergies in 2013 and approximately $20 million to $25 million of annualized pre-tax cost synergies in 3 years. We also expect this acquisition to be accretive to non-GAAP earnings in 2013.

Qualitatively, it's a great story. The team we acquired is excellent. The capabilities that they've added to an already existing strong team in our Retail business is proving to be powerful, as we design, sell and implement and service our customers. The cross-selling opportunities we're seeing are materializing and we expect our conversations with customers to allow us the opportunity to position our broader portfolio and that's working out extremely well. This is an area we're confident will continue to deliver value to our customers and shareholders moving forward.

And these results overall demonstrates solid execution cross-functionally and give us confidence in our acquisition integration capabilities, as well as our ability to grow the companies we add to NCR.

So now, let me turn it back over to Bill, so he can summarize our overall Q3 execution.

William R. Nuti

Thanks, John. I'm on Slide 7. And before I throw it over to Peter Leav, I wanted to make a few comments. Back to this notion that's important to us that strategy cannot trump operational results. And likewise, tactical execution can't trump strategy. And for us, we're trying to strike that balance vis-à-vis the reinvention of this great company. And I feel very good about that balance. And I feel really good about the performance of the company in the quarter as a result of that and the trajectory that we're on over the short and long term.

We talked about these initiatives and how they might manifest itself in the results. And certainly, software and services are 2 important metrics that we look at. But the bottom line is, are we growing the top line and expanding our margins along the way. And we have now long-term track record of now 15 quarters in a row of year-on-year growth, both on the top line and the bottom line. And that's something we intend to work hard to continue to do.

We are also investing in this business. I mean, it's clear that if you look at our expense line, we're investing in the areas where we should be investing and we're being cautious around spending in the areas where we need to be cautious in spending. And we're lining up the investments and the innovation dollars accordingly across the business. Hence, John pointed out earlier the impact that our expenses and year-over-year growth in Hospitality has had on operating income margins. That will come back to benefit us in years to come because we're putting more money into R&D and sales, as an example. But there are plenty of other examples like that around the company that we don't have enough time to go into today, but that balancing act is something we work hard on every single day in the company.

We've always believed that diversification of revenue, be it geography or industry, was important to de-risk the company, able to give us greater elements of growth in terms of the profile of growth we can drive and also sustainability long term, so that we would be somewhat less impacted by shocks in an industry or shocks in a market. And we have done a good job and continued to, if you look at this quarter, of driving very balanced growth across the geographies and industries we serve fairly well. And then, always, it comes down to making sure when you are a 130 years old that you don't forget there's a number of legacy issues you need to continue to focus on. And that every day, you have to tackle those issues so that you can transform yourself to be more contemporary around the world the way it is versus the world the way it was. And whether it's the work we've done on pension that continue to do there or the work on other issues you don't see day-in and day-out, I'm very pleased with the progress we've made this quarter.

Okay. Peter Leav, you're up.

Peter A. Leav

Great. Thank you, Bill. As Bill mentioned, third quarter results reflected steady execution across our lines of business and the ongoing progress we have made reinventing NCR.

Strong results in Hospitality, Retail and the impact of our ongoing transformation though a greater mix of higher-margin software revenue drove our overall performance. The contribution of software, which we define as software, software-as-a-service and software maintenance, increased 38% year-over-year. We remain focused on driving the evolution of the interaction between consumers and business. Our value proposition is clear to our customers and is evidenced by continued wins in each of our lines of business, as well as our steady and successful expansion into new markets and adjacencies.

Turning now to our business review, beginning with Financial Services. Revenues were down 4% during the quarter due predominantly to the expected decline in North America and, to a lesser extent, a decline in Europe. We experienced good growth outside of the U.S., particularly in Asia, Middle East, Africa, including China and India, where we had double-digit revenue growth year-over-year.

Financial Services software revenue grew 10% year-over-year, faster than our overall business in the segment. We remain enthusiastic about the opportunities in branch transformation. Our customer base is growing with 16 new APTRA Interactive services customers added during the quarter, up 20% over the last quarter. Our branch transformation solutions are designed to deliver and improve banking experience to consumers, while also helping to secure loyalty and productivity gains for financial institutions.

The ROI delivered to our customers is demonstrated by North Peace Savings and Credit Union, NPSCU, which recently won the National Credit Union Innovation Award, Canada, for its implementation of our interactive video technology. According to NPSCU, in the 12-month period following installation of the technology, nearly 1/2 of its retail members used the solution with a satisfaction rating of 79%. In the same period, NPSCU saw its net assets grow 13% and membership grow nearly 6%.

Looking at key international wins in the quarter, we secured multiple self-service ATM wins in China, totaling 4,000 units. Also, the Bank of Ningbo deployed NCR APTRA Edge, our multi-vendor software application, across its fleet of over 500 ATMs.

Outside of China, FNB, 1 of South Africa's largest financial institutions, is installing SelfServ. And our Predictive Services offering was deployed at National Australia Bank.

Turning to Retail. We reported strong results in the quarter with revenues up 17%. This top line performance includes software revenue growth of 124%, driven primarily by the addition of Retalix to our Retail Solutions portfolio. The strong growth in higher-margin software revenues led to solid operating margin expansion of 340 basis points during the quarter. Like NCR, the retail market is undergoing a transformation and this provides us with a great opportunity. Our customers increasingly need future-ready solutions that allow them to engage with consumers in exciting new ways. We believe that no other company is better positioned than NCR to help retailers of all sizes benefit from multiple sales channels, while providing a consistent, seamless and personalized shopping experience for their customers.

The combination of Retalix, Radiant and NCR puts us in a stronger position to target new markets, focus on customer and market segmentation and build greater customer intimacy. Our R10 platform revolutionizes the retail technology landscape by providing 1 innovative platform across all channels, including store, online and mobile; and across retail segments, such as grocery, mass merchandise, petroleum and convenience. Our robust retail technology and software offerings enabled point-of-sale, self-checkout and mobile-based payments for retailers of all sizes. We remain the global leader in self-checkout solutions and our NCR Silver solution provides the complete sales, inventory and marketing platform for small business owners.

During the quarter, our Retail team secured a number of key customer wins, including a self-checkout and POS agreement with a large North American general merchandise retailer, as well as a large R10 order from a specialty retailer. In addition, NCR was selected to provide retail technology solutions to 4 major shopping malls in China that seek to offer an enhanced checkout experience to shoppers and drive sales and customer satisfaction gains. We also extended our agreement with Globus Russia, who will expand its deployment of NCR self-checkout solutions to additional cities in Russia, following the successful introduction of those solutions into markets last year.

In Hospitality, we are driving solid results through our commitment to superior customer service and solutions that offer customers flexibility. During Q3, we generated strong top line performance, increased our software and SaaS revenues and drove increased operating income. Hospitality revenue has increased 25% during Q3. Year-over-year, software revenues were up 33%, SaaS revenues were up 20% and SaaS application sites grew 26%.

We secured a number of point-of-sale wins, including Boston Market's 460 locations. Our venue management solutions also continued to gain traction. We announced the 4-year agreement with the NFL's Atlanta Falcons to utilize our Netkey Endless Aisle solution, POS Counterpoint software and mobile applications and our Wayfinding interactive self-service solution.

Additional customer wins during the quarter include the historic Adelaide Oval and 1300SMILES Stadium, both in Australia, for deployment of our venue management solution. Importantly, we are well positioned and at the forefront of mobile payment adoption and can offer our customers the ability to easily integrate multiple transaction channels into 1 integrated selling platform. Our solutions offer realtime insights into back-office operations and transaction data, which enable restaurant operators to better manage their business and capture operational efficiencies.

In our Emerging Industries business, Q3 revenues remained flat, a result of the impact of a partial reduction in a large customer contract last year. In Travel, we secured multiple customer wins, including expanding our relationship with China Eastern Airlines through deployment of additional self-service check-in kiosks and multi-vendor on-site support services.

Just this week, we announced an agreement with GuestLogix that will extend omni-channel retailing to the travel industry by providing a comprehensive and secure means for airlines to sell additional products and services outside of the aircraft via mobile or self-service kiosks. The exchange of technology allows NCR to better address the ancillary revenue opportunities for our customers and improve the travelers' experience.

In Technology and Telecom, several new wins of significance occurred in the third quarter. These include a multi-million dollar services deal with 1 of the world's largest managed services providers and a new contract with Unified, where NCR is now the authorized on-site service partner for Unified voice products in the United States. Additionally, a deal was closed with 1 of the largest telcos in India for automated bill pay and queue management kiosks for 30 stores this year with the intent to expand into 400 stores in 2014 and 2015.

Finally, in our services business, we have made solid progress building our position as a leading global provider of software and SaaS applications. Our services business generated 12% overall revenue growth in Q3, with professional services revenues increasing 51%. During the quarter, we were recognized as a top technology innovator by information with due largely to our unique Predictive Services offering. This marked the third consecutive year NCR was ranked and at #24 was our highest ranking to-date. In addition to industry recognition, we also grew our services business in China with a 5-year agreement with China Resources Bank to service their fleet of over 200 ATMs.

In summary, during the third quarter, we executed against our strategic goals and delivered strong financial results. The reinvention of NCR as a hardware-enabled, software-driven company continues to show momentum, evidenced by growth in our software and SaaS offerings and the expansion of our addressable market through diversification into new product areas and channels. We are excited about our opportunities to continue serving as a trusted advisor to our customers, providing them with the innovative solutions that allow them to offer exceptional experiences to their customers.

I will now turn the call over to Bob.

Robert P. Fishman

Okay. Thanks, Peter. NCR's total reported revenue in the third quarter was $1.51 billion, up 5% versus Q3 2012 and up 7% on a constant currency basis. We reported GAAP income from continuing operations of $98 million or $0.58 per diluted share. This compares to GAAP income from continuing operations of $88 million or $0.53 per diluted share in Q3 2012.

NCR's results from continuing operations include special items in both periods. Excluding pension and special items, non-GAAP diluted income per share was $0.76 per share in Q3 2013 versus $0.64 per share in Q3 2012. To analyze NCR's operational performance without the effect of special items and pension expense, please see the supplemental financial schedule included in our earnings press release and the supplementary non-GAAP materials in the slides that Bill referred to earlier that reconcile our GAAP to non-GAAP results.

Excluding the impact of special items and pension expense, our Q3 2013 gross margin was 28.6% compared to 27.3% in the prior-year period. This 130 basis point increase was primarily driven by a favorable mix of revenue, including higher software revenues and a continued focus on cost improvement initiatives.

Operating expenses, excluding pension expense and special items, were approximately 16.3% of revenue in the third quarter of 2013 compared to 16.7% in the same period last year. Operating expenses for the third quarter of 2013 benefited from a $7 million gain on the sale of an office property.

Non-GAAP income from operations, or NPOI, was $185 million in the third quarter compared to $153 million in the prior-year period, an increase of 21%.

Third quarter 2013 segment operating margins were as follows: Financial Services increased to 12.1% versus 10.5% in the prior-year quarter due to higher software and consulting services revenue and reduced expenses. Retail Solutions increased to 10.1% from 6.7% in the prior-year quarter, mainly due to a favorable mix of revenue, including more software and the inclusion of the Retalix business. Hospitality decreased to 16.1% from 17.8% in the third quarter of 2012, primarily due to investment in sales and development resources. And Emerging Industries decreased to 18.6% from 20.9% in the third quarter of 2012, primarily due to an unfavorable mix of revenues.

Other expense was $26 million in Q3 2013, which was mainly related to interest expense. Income tax expense was $19 million in the third quarter of 2013 compared to expense of $33 million in Q3 2012.

Excluding the effect of pension and non-recurring items, third quarter 2013 effective tax rate was 18% compared to 27% in Q3 2012.

During the quarter, we recorded a one-time tax benefit of approximately $10 million related to the implementation of a tax planning strategy to access certain deferred tax assets. NCR's full year 2013 effective tax rate is expected to be 23%, significantly better than our previous guidance.

Turning to the balance sheet. Cash on hand at September 30, 2013 was $460 million, consistent with the balance as of June 30, 2013. Total debt was $2.23 billion at the end of Q3 2013 compared to $2.16 billion at the end of June 2013.

Moving over to the cash flow statement. NCR generated $27 million of cash from operating activities in Q3 2013 compared to $400 million of cash used in operating activities in the prior-year period.

Excluding the $500 million discretionary contribution to the U.S. qualified plan during Q3 2012, free cash flow was a cash outflow of $66 million in Q3 2013 compared to a cash inflow of $16 million in the prior-year period. The decrease in free cash flow was primarily driven by increases in capital expenditures and changes in working capital. NCR defines free cash flow as cash flow from operations and discontinued operations, less capital expenditures for property, plant and equipment in addition to capitalized software. We continue to expect free cash flow for full year 2013 to be in the range of $200 million to $250 million, up from $146 million in 2012.

I'd like to conclude by discussing our guidance for 2013 and providing an update on Phase III of our pension strategy. The revenue guidance by line of business has been updated from our previous guidance provided during the Q2 earnings call. The guidance for our lines of business include services and is on a constant currency basis. We are seeing roughly 2 points of FX headwind versus the prior year on a total company basis.

In Financial Services, we now expect revenues to be roughly flat. In Hospitality, we expect revenues to increase towards the higher end of the 15% to 18%. In Retail, we now expect revenues to be up 24% to 26%, higher than our previous guidance. Retail revenues, excluding Retalix, are expected to grow 7% to 9%. In Emerging Industries, we expect revenues to be up 3% to 5%. We're also reaffirming our previously issued overall GAAP and non-GAAP guidance. In terms of total revenue, we expect 9% to 11% growth on a constant currency basis. Our 2013 NPOI estimate is $700 million to $720 million and our non-GAAP EPS guidance is $2.70 and $2.80.

For Q4, we expect NPOI to be in the range of $204 million to $224 million or growth of 13% to 24% year-over-year. Additionally, we expect the Q4 effective tax rate to be approximately 30%, coming off a strong 18% in Q3. And other expense, net including interest expense, to be approximately $25 million in the fourth quarter.

Turning now to an update on Phase III of our pension strategy. We continue to make progress with our de-risking initiatives with the $100 million contribution to our U.S. pension plan on October 1 and the expected completion of our lump sum offer to the remaining vested terminated employees in the fourth quarter. We believe the various actions taken this year will reduce our global underfunded status by about 50% at the end of the year versus the end of last year, assuming no significant changes in the markets or discount rates in the fourth quarter.

And with that, I'll open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Paul Coster with JPMorgan.

Paul Coster - JP Morgan Chase & Co, Research Division

First of all, seasonality. The guidance calls for a pretty strong fourth quarter and this is quite typical for you. But can you just remind us why that is possible, particularly in the Retail segment where I mentioned that the end customers is a bit reluctant to be upgrading?

William R. Nuti

Yes. Paul, we usually have, as you know, seasonally, a strong fourth quarter. There's always a number of factors to that notwithstanding the fact that it is the end of our fiscal year and it's always a big push on behalf of all of our sales teams to close strong. There's also a big push on some point of our customers to finish the year with the investments they've made earlier on the year in terms of installations. Installations of ATMs, self-checkout, point-of-sale, software programs, all of our customers are on budget. They're annual as well and they wanted to get the projects done. So we typically see a stronger fourth quarter as a result of that.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. Obviously, I applaud the reduction in OpEx as a percentage of revenue. I appreciate that much of your R&D is effectively acquired through acquisitions. But nonetheless, it's 3.5% of sales. Now R&D seems to be low, Bill. Can you just sort of reassure us that there's no compromise here on the rate of innovation of this company? And if so, how has the company's moved such a modest total R&D spend?

William R. Nuti

Paul, my CTO is staring at me here.

John G. Bruno

Thanks, Paul. Thank you for asking that question. They're going to think I saved you, but I can give you my perspective after Bill.

William R. Nuti

I'll let John answer next. But R&D spend, Paul, as a percent of overall revenue, is up significantly year-on-year and has been growing sequentially now for the last several years. So I feel good about the growth of our spend in total. And we're being very laser-focused as to where we spend our R&D, Paul. And we're doing a good job of recycling spend away from more commodity areas into more higher-margin areas, so I think more software. But I would say that the combination of the additional expenses that we bought in the Retalix and Radiant acquisition, combined with good solid management on the NCR side, is why we're able to manage that quite well. By the way, we're not compromising anything. If anything, we're investing. John?

John G. Bruno

Yes, that's -- and that's fair, Paul. The real key issue is, just a number of years ago, it's really only 3 or so, we made the decision to align all of the various different research and development divisions into 1 organization and consolidate and focus on platforming. And a big part of the ability to refocus our efforts has been that we had tremendous amount of reduction across parts and using common capabilities across each of our platforms. And that's allowed us to very nicely quarter-after-quarter continue to reshape our portfolio in this space. And that, plus the acquired capabilities and abilities to rationalize plus the software, has allowed us to maintain what we feel is an appropriate level of expense to revenue there especially given the increased software content. So while I'm always going to push for more research and development, it's always going to be a balanced set of investments against our strategy and what we can execute in any given fiscal year.

William R. Nuti

Yes, Paul -- and only the point I would make and I'm not protesting too much here but we're taking your question personally. But I would say that you always have to be very careful that when you are investing the dollars, you're investing them appropriately and you don't waste them. So we're being very careful given that our ratio of expense to R&D is up that we're not being wasteful along the way.

Paul Coster - JP Morgan Chase & Co, Research Division

Okay. My last question, on Financial Services. It feels like, year-on-year, comps get easier at some point in this fourth quarter. It looks like the bookings are quite strong. Do you feel confident that we'll be seeing year-on-year growth next year in that context plus the overlay of branch transformation?

William R. Nuti

Yes, the answer is yes to your latter question. But to some context on that, bookings or orders in Q3 was up 17% in Financial Services. It was a good quarter for that business in terms of orders, mainly driven by the Americas, but not the U.S. Still, as I said, on the Q2 call, I'll say again today, my key metric for that business in terms of growth is when will the U.S. have year-over-year order growth. I'm expecting that in Q4. I'll report back to you in January on how we did, but I'm expecting that in Q4. That being said, I was very pleased with overall order growth in Financial Services. By the way, the company order growth was up 17% as well in the quarter. So we were able to claw back some of the backlog deficit we built for ourselves, but we have to continue to grow orders in Q4 consistently and then in Q1. But I have a lot more confidence, Paul, in growing revenue mix here in Financial than I did at the beginning of this year.

John G. Bruno

I think the other good thing, Bill, and sitting in the backlog, is the gross margin dollars are up year-on-year. So that's the gross margin sitting in backlog and that's primarily because of the mix of the business, more PS, professional services and more software sitting in that backlog.

Operator

We'll take the next question from Meghna Ladha with Susquehanna.

Meghna Ladha - Susquehanna Financial Group, LLLP, Research Division

So, Bill, it looks like, based on your guidance in Financial Services, the U.S. ATM business still remains weak. I mean, as you're talking to your customers, especially the regional banks, can you share with you some of the discussions you're having with them ahead of the AEN, Wi, Windows 7 deadline?

William R. Nuti

Well, I think your characterization is right, Meghna, but the 1 caveat I would say is it's not unexpected to us that the U.S. ATM business was going to be weak until about now. It would be less expected based on my comment earlier to Paul around my expectation that Q4 order growth in North America will be up. But it has been weak and it has been on the back of tough compares and on the back of the secular upgrade cycle we saw in the spring and summer of last year. Comments from the customer base or dialogue with the customer base has been relatively positive from the point of view that, in all cases, our customers are going to have to do something around Win 7 and EMV. It's more of a Windows 7 story less than EMV story. EMV is out there in '15. And candidly, it will probably be moved again at some point. Those things do move around. Win 7 is a real issue and that's something we're beginning to see activity on. And then, separately, for us, that particular space is a space where branch transformation is getting a lot of attention. So I think that, that has good potential in '14 and '15 for more significant growth. Do you have anything to add, guys?

Robert P. Fishman

[indiscernible] You said it well.

William R. Nuti

He said I did a good job. Okay.

Meghna Ladha - Susquehanna Financial Group, LLLP, Research Division

Okay. With branch transformation, a quick question. So what is the revenue contribution year-to-date? And are you reiterating the $80 million to $100 million guidance for the year?

William R. Nuti

Yes. I think when you look at all-in hardware, software, services, PS and all of that, yes, I think we'll have the guidance of $80 million to $100 million. Right now, orders at the end of Q3 was at $50-ish million. And so, I think we're going to have another strong Q4 in orders. So I think the order rate will probably be around $90 million when it's all said and done in branch. And as I said on the last call, I'm still expecting next year to be $150 million to $200 million, in that range.

Meghna Ladha - Susquehanna Financial Group, LLLP, Research Division

Okay. And the last question on Retail. Bill, Wal-Mart recently at the Analyst Day, they said that they're adding self-checkout systems to more than 600 stores by the end of the year. So is it safe to assume that NCR is going to be the vendor here [ph] since Wal-Mart is 1 of your biggest customers? And if yes, how should we think about the revenue opportunity from this announcement? And was this -- is this factored into your current guidance?

William R. Nuti

Meghna, I'd love to comment on that but I can't, so I won't. But I will say this, this is not Wal-Mart related. This will be -- we did win 2 other major contracts in self-checkout recently that are quite significant in size and I would say it could rival the initial Wal-Mart order we received a year ago. So these are big deals. And so, I do think that self-checkout, per se, has a bright future in the company, at least for 2014 and '15, given my expectation around these 2 new wins and what might occur in the market generally and globally.

Operator

We'll move next to Kathy Huberty with Morgan Stanley -- or Katy Huberty.

Kathryn L. Huberty - Morgan Stanley, Research Division

Just first, what was the thought process behind not flowing through the NPOI and EPS data in the third quarter? Is that just the tax rate volatility, or were there some weak areas? I think you mentioned, in the Retail business, revenue conversion wasn't what you thought you want to see how that plays out.

William R. Nuti

Well, I'll answer it and then Bob will give you his perspective. But in the quarter, I'd say, Katy, the quarter kind of worked out the way we thought when you adjust for some of the other items. We knew, coming into the quarter, we had the potential for these tax benefits when we gave you our guidance in Q2. So they were not a surprise to us. So we included that in our perspective in the quarter. We also knew we had the small real estate gain coming, so that was included in our guidance as well. But to your point, I think, if there was 1 or 2 areas where, I would say, we could have executed better, 1 would be Retail. I'd say about $20 million in revenue we should have captured but did not in the quarter. So that has a flow-through -- I think, gross margin is around $6 million. And to a lesser extent, I'd say, in Financial, but financial had a great quarter overall from the profit perspective. Andy is doing a really nice job of reshaping and transforming that business in the bottom line of that business and being very disciplined about the business we take versus we don't take. So I was pleased with that, but I would like to see a little bit more, just a tad more sell and bill, out of that business in Q3.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. And then, on the free cash flow side of things, still tracking below earnings. You've talked about that in past quarters. Is there anything that you pinpointed, Bill, in terms of processes or particular business segments where you think you can go and really have a near-term impact on the cash cycle in the next few quarters?

William R. Nuti

Well, I'm going to say this, I mean, cash flow is behind operating the business day-in and day-out well, in terms of my #1 priority being a good operator. Cash flow is #2 for us and we're getting very focused on cash flow generation. We have to. We just have a great machine here that should generate higher, more consistent, more linear cash flow. My disappointment on that in Q3 was mainly on the working capital side, mainly accounts receivable, but we'll get that sorted in Q4. Bob has a plan. We have a plan to get that nailed down. And we're also working together on jointly getting a better linear overall performance of cash flow in '14.

Robert P. Fishman

Yes and I would agree. I was equally disappointed with the free cash flow. Q4 is always a big quarter for us in terms of generating free cash flow. We always collect more of our receivables as a percentage of what's due in that last quarter. So I'm confident we'll hit the range that we gave. So overall, it's just a matter of being very focused on collecting on our cash starting here in October and November and driving that forward through the month of December. So again, a little bit more back-end loaded that I like, but still on track to achieve our goal.

Kathryn L. Huberty - Morgan Stanley, Research Division

Okay. And finally, I know you have to wait until December 31 to finalize the pension accounting. But given where interest rates are now, I imagine the underfunded position comes down quite a bit, does that mean that you have less cash outflow in the next couple of years and we could actually -- you'll see nice free cash flow growth just on the back of that going forward?

Robert P. Fishman

I think that's a true statement. We gave the comment that the underfunded position would improve by about 50% at year end. And that's really a combination of a couple of big initiatives we undertook. One was the senior executive plan, one was the prefunding done here recently in October, but also the trending up of the discount rate has helped. And no -- even though we're fairly well notched from an immunization perspective, that rising discount rate has helped us this year. So I think all of that helps in terms of reducing the underfunded. And the big initiatives as part of Phase III will improve the free cash flow in the outer years. So it's all helpful.

Operator

We'll take the next question from Dan Perlin with RBC Capital Markets.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

I wanted to kind of drill down on this point you just made a second ago. You talked about gross margin dollars embedded in your backlog are much higher from a margin perspective. I guess the question is, order growth was up 17% for the company, how do we think about that if we're parsing it software and services as a component of that versus just, like, a unit component?

William R. Nuti

Yes...

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Because I think that's -- I mean, that's clearly key to the story.

William R. Nuti

Yes -- no, it's a great question, Dan, because we look at it every day. So we look at software and services as a percent of our overall backlog. And the growth of software and services as a percent of our overall backlog has been going up quite significantly. So when Bob mentioned Financial Services -- it's not just them by the way, but that division -- you would see that their overall gross margin dollars in the backlog, even though the backlog is down year-on-year, the gross margin dollars are up in that business by about $29 million year-on-year. Software as a percent of the backlog is growing 40% year-on-year. So...

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

And that's just for Financial Services, right?

William R. Nuti

Yes. Good growth in that space. So think about us measuring -- when we look at our funnel and our backlog, we have a forward-looking metric, which is our funnel. We have a backward-looking metric, which is our backlog. And we look at software as a percent of those every day. So making sure that the mix of our funnel and the mix of our backlog is improving with our strategic goals and metrics that we measure ourselves to. As we get that margin yield, we're looking for both long-term in the funnel and short-term in the backlog. You with me on that?

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

I am. So that leads me to my next question, which is of the incremental dollars that you're bringing through with orders, how much of that is software and services as a mix?

William R. Nuti

It's a lot better...

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Is it more than 50% or 60% or 70% or...

William R. Nuti

Of the incremental?

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Yes. So the forward-looking, right, what you're bringing -- what you're going to -- what we're going to see into the '14 numbers and beyond because we -- you gave us these aggregate numbers and they are very helpful, $725 million, the $775 million and the like, but I'm thinking of these incremental dollars that are being brought in through all these new orders. I'm just trying to think of it in aggregate. What percentage of your new business that's brought in is really coming from software and services?

William R. Nuti

It's a great question, but I don't have the math in front of me now, but we look at that. Dan, we'll come back to you on that. If we can get it during the call, I'll give it to you.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Maybe Analyst Day?

William R. Nuti

Yes. We're looking forward to Analyst Day. Just a point I'd like to make on that is that we're pretty jazzed up about Analyst Day and meeting with all of you guys and giving you our outlook on the business. By then, we'll give you some perspective on the answer to that question as well.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Okay. Can I just ask 1 more real quick. The 2 major deals that you talked about in self-checkout, which obviously sound meaningful, are each 1 rivaling the original Wal-Mart or, in aggregate, they would rival that? And if so, should we be expecting those in kind of a '14 -- early part of '14?

William R. Nuti

One of them will rival the size of the initial Wal-Mart order by itself. And the other will be smaller, but has more -- has equal upside long term, depending upon the uptake. So combined, I'd say, they are both larger than the initial Wal-Mart order, yes.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Okay. And then, the timing?

William R. Nuti

Now through '14. We'll start shipping in Q4.

Daniel R. Perlin - RBC Capital Markets, LLC, Research Division

Okay. And then, 1 last question was, you did mention that you were disappointed on the conversion on Retail. $20 million is really kind of the jump you thought you should have had. It wasn't clear as to why. Like, what was the key driver to your disappointment on that? Obviously, you wanted more revenue, but what didn't allow you to get it, I guess? What happened there in the quarter?

William R. Nuti

Well, I'll -- Dan, I'll use the word missed execution because it comes down to that. But what's happening a bit in the company is as we become more of a software-driven company, we're also transforming internally. So oftentimes, when software deals come in at the end of the quarter, and you would know us to have a fairly strong governance and financial focus on our books and records, if the "I"s are not dotted and the "T"s aren't crossed, we're not booking it. So our teams out there in the field are learning how to sell software, learning how to get them done correctly in a timely way. And you also know software businesses tend to be back-end loaded from a linearity point of view. And so, when we have those issues, we had some software deals that were reasonably good margin deals to split quarter-to-quarter and it was sloppiness on our part.

Operator

We'll take the next question from Ian Zaffino with Oppenheimer.

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division

Just very quickly, the free cash flow you're talking about, of the $200 million to $250 million, where does that go and what do you intend to do with that? Is it acquisitions? Is it -- are we going to see a resumption of buybacks, de-levering? What are we doing?

William R. Nuti

I'll answer it and then Bob will jump in. Some of that will go to paying down the debt. Some of that might go up as an acquisition we find that is interesting and meaningful to that. And some of it may go to working capital. It depends upon where the cash comes from and where we -- what we end up doing. So it's all of the above. Is that fair, Bob?

Robert P. Fishman

Yes, I agree.

Operator

We'll move next to Kartik Mehta with Northcoast Research.

Kartik Mehta - Northcoast Research

You might have answered this question, so I apologize. I just want to make sure that I understood it. As far as the ATM business is concerned in the U.S., how much was it down compared to year ago?

William R. Nuti

Mid-teens.

Kartik Mehta - Northcoast Research

Mid-teens?

William R. Nuti

I think we -- yes, mid-teens down year-over-year. And revenue I think is 16% down year-on-year. So another great quarter, but a tough compare. And I think that was the key driver of -- as I said earlier, the rest of the world for our ATM business is actually doing quite well. We had a great quarter in a number of key countries that we're doing business in: India, China, Turkey, Middle East and Africa had a fantastic quarter. So it's really a U.S. story for now. And as I said earlier, the key metric we all want to track, all of us, is real growth in North America.

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division

So in the U.S., was it just retail banks where you saw the weakness, or was this pretty broad-based and it was also in the national banks as well?

William R. Nuti

Across the board, but regional is a little bit more weaker then the nationals.

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division

And then, Bill, the 1 area you seem to have be having good success on the Financial Service side in software. It seems like 1 of the reasons you said your margins were up year-over-year. Are you able to quantify the percentage of software now as part of the ATM business? Obviously, you have hardware services. So I was just wondering if you're able to parse out how much is software now compared to year ago?

William R. Nuti

Yes, I think we can. We'll give it to you at Analyst Day as well. But I will say this, software and SaaS revenues were up 10% and 8%, respectively, in Financial Services year-on-year. That's a big number for us in that business because that's -- the base of software in Financial Services is not small.

Robert P. Fishman

Yes. And overall, for the company, I think we gave the number out for software as a percentage of total revenue. Last quarter, it was about 12%. This quarter it's 13%. And I think Financial probably falls in line very similar to the total company.

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division

And then, just 1 last question, Bill. In the emerging markets, especially in India, are you seeing any greater price competition? It seems like that market is really growing. And I just don't know as new entrants might be trying to enter if you're seeing any price competition.

Peter A. Leav

Hey, Kartik. It's Peter Leav. We're seeing the transition as it relates to business model, but it's no more or less competitive than it had been and we're seeing very significant growth as we not only aspire to continue to grow and take share, but we have aligned with the model that's come to fruition in that market. So the short answer is no, but the model is something that's caused major transition and provided us a great opportunity to continue to grow and we certainly did so in Q3 in India.

Operator

[Operator Instructions] We'll move next to Matt Summerville with KeyBanc.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Just a couple of questions. First, in the ATM business, you talked about most regions of the world with the exception of Europe. Can you talk about, Bill, orders, the overall performance there in Q3 and what you're expecting over the next several quarters?

William R. Nuti

Yes. Order growth, Matt, in EMEA, was up 21% in the quarter. So we had solid order growth quarter overall. But in Financial Services, it was up 15%. So the total company was up a bit more than Financial Services. Revenue for EMEA was down slightly, a couple of points, I think. But if you FX adjust for that, probably not down -- I mean, up slightly. And so, good solid quarter for Financial in orders. As expected, given the backlog going into the quarter, for revenue. I would say that the thing that I was encouraged by for EMEA was growth in orders in Italy, Iberia, France, the U.K. and the Middle East and Africa in particular. They had all good quarters.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then, with respect to Hospitality, can you talk about, maybe, when you bought Radiant, what is the percent of revenue the company was spending on what you're calling sales development and what that percentage looks like today and when you start to get leverage on that?

William R. Nuti

It's a lot higher today, Matt, I can tell you that, a lot higher. Our expenses in sales alone are up 30% year-on-year in Hospitality. I expect to get leverage from that in '14 and '15. It takes about 18 months to 24 months for salespeople to get fully productive in terms of productivity per head when you -- after you hire them. A good percentage of those hires are on SaaS as well. So SaaS, you don't see SaaS hit you like you do enterprise license revenue or hardware revenue, it takes more time. But that's money well spent because the margins, obviously, move up in the right direction as they gain traction. So 1/2 of the investment, if not slightly more of that, has been in SaaS reps; and the other 1/2 in international account managers.

Robert P. Fishman

I think the other place, Bill, is we're probably giving them about 30% to 33% more in software cap. So again, these are the development dollars being used to create the next generation of applications that they can add to their stack. So again, it's forward investing where the benefits will come through next year and the -- and in future years.

William R. Nuti

Did you hear that, Paul Coster?

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then, just 1 last 1 real quick. Bill, I think you mentioned and I just want to make sure I'm clear on this, the $10 million benefit you had in taxes that seemed discrete in nature. That was or was not in your guidance for 27% effective tax rate in Q3? And then, the same with the $9 million in gains.

Robert P. Fishman

Yes. The guidance we gave for Q2 was -- did not include that. What we did is, in the Q, we foreshadowed that we will work in this issue. And so, giving some indication but really needing to kind of work through and complete that tax planning strategy. So again, that's how we did the disclosure there.

William R. Nuti

It was included in the Q3 guidance, the $175 million to $180 million. I think -- are we talking about Q3 or the year?

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Yes -- no, I'm talking about Q3 and I'm talking about 2 sort of separate things, I apologize, so...

Robert P. Fishman

I'm sorry. I said Q -- I think in Q3, we gave a tax rate of 27%, Matt.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

Correct.

Robert P. Fishman

Okay. That included in the 23 -- 27% was not -- this one-time item was not in there. What we did with this item was, in the Q, we suggested that we were working through a tax planning strategy. So that's why, when we came up with 18% here for Q3, that's basically the difference between the 27% guidance and that's also why I need to kind of do a reset and have a 30% in Q4.

William R. Nuti

Exactly.

Robert P. Fishman

Overall, for the year, it gives me a 23% rate, which is pretty good when you look at the last 3 or 4 years.

William R. Nuti

Exactly.

Matt J. Summerville - KeyBanc Capital Markets Inc., Research Division

And then, the $7 million you mentioned that helped the op expense, Bob, was that in or not in the guidance? I missed that earlier.

Robert P. Fishman

We gave guidance of $175 million to $180 million, Matt. And we've landed on $185 million. So the guidance that we gave did not have this in it. Overall, though, we were able to achieve within our range. I put that item, again, Bill was talking about legacy items, legacy issues, this was an office building that we held and were able to sell in the quarter.

Operator

And it appears we have no further questions at this time. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

William R. Nuti

Yes. Just some closing comments around the Analyst Day. It is coming up on November 11 and we're looking forward to seeing everyone there. Again, we're enthusiastic about meeting all of you and giving you our next 3-year update on revenue and NPOI and EPS guidance. We'll see you there.

Operator

That concludes today's presentation. Thank you for your participation.

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