NCR Q3 2006 Earnings Call Transcript

Oct.26.06 | About: NCR Corporation (NCR)

NCR Corp. (NYSE:NCR)

Q3 2006 Earnings Call

October 26, 2006 10:00 am ET

Executives

Gregg Swearingen – IR

Bill Nuti - CEO

Pete Bocian - CFO

Analysts

Reik Reed - Robert Baird

Matt Summerville - Keybanc

Richard Farmer - Merrill Lynch

Kartik Mehta– FTN Midwest

Katie Huberty - Morgan Stanley

David Dillinger – Merger Market

Operator

(Operator Instructions) I would like to turn the call over to Mr. Greg Swearingen, Vice President of Investor Relations. Sir, you may begin.

Gregg Swearingen

Good morning and thanks for joining us for our 2006 third quarter earnings call. Bill Nuti, our CEO will lead off our call, after which Peter Bocian will discuss our Q3 financial performance, as well as our increased guidance for the full year 2006.

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 risk and uncertainties that could cause actual results to vary materially. These risk factors are described in NCR’s period filings with the SEC and our annual report to the 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 be available later today on NCR's website, which can be accessed at NCR.com. For those listening to the replay of this call keep in mind that the information discussed is as of October 26, 2006. NCR assumes no obligation to update or revise the information included in this conference call, whether as a result of new information or future results. Now I'll turn the call over to Bill.

Bill Nuti

Thank you, Greg. Good morning to everybody. Thank you for joining us as we discuss our third quarter results. I am pleased that we improved our year-over-year operating performance even as we increased our investment and continue to take actions to improve our future revenue growth and operating performance.

The improved operating performance was led by good revenue growth in Teradata and in our retail store automation business, as well as strong growth in ATM maintenance revenues. This increase in the mix of NCR branded maintenance revenues and continued operational initiatives helped to drive the improved operating margins in our customer services division.

I will now discuss the business unit results starting with our Teradata Data Warehousing business. Revenue of $378 million with up 5% from a very strong Q3 2005 which saw 16% revenue growth from Q3 2004. Operating income increased to $75 million in the quarter, as higher revenue more than offset Teradata's increased investment and demand creation resources and research and development.

In the quarter, Teradata added new customers including Air Canada, telecommunication providers include Vodafone Spain, Movistar -- which is a mobile phone company in Argentina -- and Kyvistar, Ukraine's leading mobile phone provider. Dex Media, one of America’s largest publishers of phone directories, as well was a new customer added in the quarter. We added several other new customers in the quarter who requested that we not mention their names, including one of America's largest manufacturers.

Additionally, as our existing customers continue to drive incremental business value from their data warehouses, they increase the size and scope of other data warehouses. Some of the customers who expanded their enterprise data warehouses during the quarter include major retailers such as Lowe’s, Overstock.com, Metro AG in Germany and Tesco stores in the United Kingdom. Telecommunications including PolkomTel in Poland, Singtel Opus in Australia and China Mobile. Manufacturers including Freescale Semiconductor and General Electric Health Care. Financial institutions such as Westpac Banking, Barclay's Bank and Bank of America. Also in the quarter FedEx and CMS, which is the Centers for Medicare and Medicaid Services, upgraded their data warehouses.

Overall the financial, manufacturing and government verticals showed good results for Teradata in the quarter. As another sign of the strong demand for Teradata, more than 3,000 people attended the Teradata user group conference this past September. This was truly an energizing event where I had the opportunity to meet and discuss enterprise analytics with many passionate Teradata customers, prospects, partners and employees. The demand for Teradata and enterprise analytics remains very high.

Let me turn to financial self-serviced. Third quarter revenue of $349 million was the same as was reported in Q3 2005. The revenue comparison included 2 percentage points of benefit from currency translation. Operating income for the division was $43 million, down from $60 million in the third quarter of 2005. As expected, in the quarter we saw lower revenues in the United States market versus the extremely strong environment we saw in 2005. The strength in 2005 was driven largely by upgrade activity related to compliance requirements like Triple [Dez] and the Americans Disability Act.

As most of this activity is behind us, and the deployment of Check 21 related deposit modules are just starting to ramp up, this puts pressure on profit margins. Due to the adverse revenue mix and the under-absorption in our North American manufacturing facility.

Cost reduction efforts continue to be a major focus area, however, cost reduction was not significant enough to offset the adverse revenue mix and moderating price erosion in the quarter. Going forward, the company's newly opened manufacturing facility in Budapest Hungary, coupled with our continued actions to streamline our operations should enable incremental cost reduction.

As it relates to the future, our backlog of orders in our ATM business is outpacing last year's level. This, combined with the roll-out of deposit automation technology, should help both the top and bottom lines of this business unit in 2007 and beyond.

Additionally, the double-digit growth of our ATM maintenance revenues was one of the drivers of improved operating profits in the Customer Services division. NCR's Customer Services division increased profitability by 400 basis points in the quarter on slightly higher revenue. This came as a result of both a favorable shift in revenue mix and continued execution on a number of operational initiatives.

We saw ATM maintenance revenues increase 13% in the quarter while revenues from lower margin maintenance of third-party products declined by 14% percent. For future margin expansion, we are continuing to improving our pricing and mix of revenues as well as making operational improvements in our service delivery cost structure.

Now let me discuss our retail store automation business. I am pleased to report that our retail group grew both revenue and operating income as compared to the third quarter of last year. Revenue of $219 million increased 5% from the year-ago period. Operating income increased 33%, to $12 million in the quarter. Retail store automation revenue mix improved in the quarter as we drove a higher percentage of revenues from self-service technologies. Self-service revenues grew double-digits while assisted point of sale revenues declined.

We see mixed signals among retailers. Although all retailers are cautious about spending, recent same-store sales data suggest a more stable environment, leading us to be cautiously optimistic about the future of our retail business.

Overall, it was a good quarter for NCR; however, we still have a lot of work to do in front of us to complete and to drive both the top and bottom line results in the future. But I am proud of the team. I'll now turn the call over to Pete to review our financial results.

Peter Bocian

Thanks, Bill and good morning, everyone. Total revenue in the quarter was roughly $1.52 billion, up 1% year on year with one point of benefit from currency translation. We reported GAAP net income of $89 million or $0.49 per share versus $222 million of net income or $1.18 per share in Q3 of 2005. The prior year reported EPS included $142 million or $0.76 per share of non-typical tax items. Excluding these tax items, EPS was $0.42 in Q3 of 2005.

Total company non-pension operating income, or NPOI, was $151 million in the quarter, compared to $143 million in the prior year period. In the quarter, we had pension expense of $33 million compared to a $31 million pension expense in Q3 of '05. 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 web site that reconciles GAAP to non-GAAP results. For the remainder of my comments, I'll exclude the impact of pension.

NCR's gross margin was 30.3% in the quarter, a slight improvement from 30.2% in last year's third quarter. NCR's expense ratio improved from 20.6% of revenue in Q3 '05 to 20.3% this past quarter. Our tax rate in Q3 was 26%, which was higher than the 22% anticipated for the full year, due to the mix of profits and losses by country reported in the quarter. We still expect our tax rate for the full year to be 22%.

Moving to the cash flow statement. NCR generated $142 million of cash from operating activities in the third quarter of 2006 versus $140 million in Q3 of '05. We used $52 million for capital expenditures versus $39 million in the third quarter of 2005. As planned, CapEx was higher due to certain real estate related initiatives and increased investment in software development.

Free cash flow was $90 million compared to $101 million in the year ago period. Free cash flow in the quarter was impacted by the higher capital expenditures. We calculate free cash flow as cash flow from operations, less capital expenditures for property, plant and equipment, and additions to capitalized software.

For the full year, we expect free cash flow of $310 million to $320 million. This reflects approximately $190 million of capital expenditures. Keep in mind our stated CapEx and cash from operations will be lower as a result of the accounting change we made in Q2 relating to re-workable service parts. This change does not impact free cash flow as both CapEx and cash from operations are reduced by the same amount.

Depreciation is also revised downward as a result of the accounting change, as CapEx will be lower. We now expect depreciation of roughly $160 million for the year. Over time, we expect CapEx and depreciation to run at a one-to-one ratio.

During the quarter we repurchased approximately 2.8 million shares of NCR stock for $94 million. We now have about $264 million of remaining board authorization available for future share repurchases. With only 228,000 options exercised in the third quarter, our repurchases far outpaced the option activity driving a favorable impact to both Q3 report and expected future EPS.

Before I move to guidance I would like to spend some time on the U.S. pension action we announced a few weeks ago. In the quarter, we announced our plan to freeze our U.S. pension plan as of December 31, 2006. For all employees affected by this change, we will be offering an increased company match to the current NCR-defined contribution 401(k) savings plan.

This change, which moves us more in line with the competitive marketplace, should reduce our annual pension expense by about $40 million, incremental to our earlier expectations.

Prior to this 2006 pension action, the $146 million of pension expense expected for '06, excluding the $9 million customer services early retirement program, would have declined over time due to the pension action taken in 2004. This most recent action accelerates the realization of the lower expense. Assuming that we achieve our expected returns and discount rates remain constant, 2007 pension expense would have likely been in the $120 million range. Now, 2007 pension expense is likely to be $40 million less, in the $80 million range.

Because of the 2006 change to the U.S. pension plan, we were required to complete a re-measurement of the U.S. pension plan at the end of the September. As a result of this re-measurement, we increased the interest rate assumption for 2006 by 25 basis points to the current market rate and reduced the expected return on assets assumption by 25 basis points which results in pension expense for 2006 to be about $10 million less than previously expected.

Therefore, pension expense in Q4 of 2006 should be about $29 million, with total year pension expense expected to be $133 million or $142 million, including the expenses associated with the Q1 Customer Services early retirement program.

We were also required to record an adjustment to our additional minimum pension liability on the balance sheet. The pre-tax effect of this non-cash adjustment was a $385 million increase to stockholders' equity. This non-cash adjustment did not have any impact on earnings for the third quarter and reversed a significant portion of a pension-related charge that we took against stockholders’ equity in 2005. We will give a further update on our expectations regarding 2007 pension expense in January, as we again will update our assumptions in line with our annual review.

Now moving to our guidance for the remainder of the year. We are increasing our full year 2006 GAAP earnings per share target to $1.90 to $1.95 range and our non-GAAP EPS to $1.94 to $1.99, primarily due to the lower pension expense as well as a slightly better Q3. We still anticipate about 1 percentage point of total company revenue growth for the full year, with minimal impact from currency.

Our guidance for full year growth for Teradata remains 5% to 7%, although we still expect to be at the low end of the range and our EPS guidance assumes about 5% growth. Financial self-service revenues should be flat to down 1% for the year, as some revenues previously anticipated in Q4 from a number of large transactions in the Americas are now anticipated in 2007.

Retail store automation will likely grow 2% to 3%, with double-digit growth in self-service offsetting declines in traditional POS. Customer Services revenue is now expected to be only down 1%, as ATM maintenance growth is largely offsetting the planned declines in third-party revenues.

In terms of operating margins for full year 2006, we continue to expect 10% NPOI margins for the total company. For the business units we expect Teradata to generate 21% to 22% operating margin, financial self-service operating margins to be approximately 12% for the year. Retail store automation is anticipated to be about 4% while customer services is expected to be slightly above 5%. As we mentioned earlier, we expect pension expense of $133 million and the full year of 2006 tax rate to be 22%.

Now let me turn the call back over to Bill.

Bill Nuti

Thank you, Pete. Before we open it up for questions, I really wanted to thank the NCR team, our employees and also our partners for their diligent efforts in the third quarter. Overall, I'm generally pleased with our third quarter performance. That doesn't mean we cannot improve but I'm generally pleased.

Teradata had a good revenue quarter on the top of a tough comparison in both retail store automation and customer services improved their year-over-year profitability. But clearly we are not satisfied with the financial self-service profitability and performance. However, we understand the issues and we are executing on specific initiatives to improve the margins in that business.

I also want to reiterate that we remain focused on executing our key strategies which of course starts with building a sustainable and competitive cost structure for the company's future. Secondly, driving a plan to achieve higher profitable growth. And third, evolving our company to a more customer-focused culture. By maintaining a competitive cost structure and improving our operational efficiencies we will be able to both invest for future profitable growth and deliver market-leading products and services to our customers.

At this time, operator, let me turn the call over to you for a Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Reik Reed - Robert Baird.

Reik Reed - Robert Baird

Can you guys talk a little bit about in the ATM space you have lowered the guidance. Pete, I think in your comments you talked a little bit about some push outs occurring. Can you talk first why those push outs might be occurring fourth quarter into '07? Then can you also talk a little bit about with the ATM market overall, the international market seems to be doing pretty well, you guys have very good position in those markets. Why aren't those international markets offsetting some of the weakness, more so than they are, in North America?

Peter Bocian

I think if you look at the guidance flow through the year for the top line for the ATM business, we started out with a flat expectation. We moved it slightly higher at Q2, up to 1% to 2%. Now we are saying it is probably going to be flat or slightly down. And it really all revolves around the Americas. We had hoped to get some larger deals and/or a little more traction in the deposit space in this year.

Strong backlog, as Bill mentioned though, so I think we are getting a build in backlog, as you mentioned, in the international space. We are getting good activity. I'll let Bill comment a little more.

So the history is we have been gravitating around the flat scenario; got a little more optimistic in Q2. With we see now is strong backlog but it won't roll out as fast and probably a little softer in the Americas, though it is push out as opposed to any lost business. That's why we are currently flat to slightly down, and then at the lower end of the 12% to 13% OI margins that we told you about in July. Bill.

Bill Nuti

Just a couple of added points. The Americas this year is challenged; for one reason we had a great 2005 in the Americas. So I think one of the things I would point out, while we are disappointed with the Americas performance in financial self-service, it is off of a real tough compare. I don't think from a market share point of view we will lose market share in the U.S. Now I'm waiting to get more detail on that, of course. But my general consensus here right now is while we need to do a better job in the U.S. we are not going to lose any share.

The market itself in the U.S., you know, without the effective deposit kicking in is largely a replacement market today. We have some initiatives in place to drive growth in this particular market, but generally speaking, deposit is going to be the next growth engine for this market. And without the ADA and without some of the other what I would call regulatory growth initiatives we had in the past, it is what it is.

It is also a good point to make that in Europe, in particular, we have seen very solid growth. What we are finding and what we found actually is it takes a little bit longer for rollouts outside the U.S. than inside the U.S. so our U.S. customers tend to roll out their ATMs at a more rapid clip. We tend to draw down on the backlog faster in the U.S. than outside the U.S. There's a variety of reasons for that. So to the point that Pete made and I made, that's why backlog is going up as well in that regard, because a lot of backlog is related it to international orders sitting in the backlog.

So we are seeing good international growth in ATMs, the margin structure in that part of the world is not as high as it is also in the Americas. So that features prominently in our overall profit picture. But generally speaking, Reik, I would say those are probably the key points to take away from the quarter.

Reik Reed - Robert Baird

Okay. And then Bill, with respect to RoHS in Europe, can you answer two questions on that? The amount of shipments that might have gone from second quarter to third quarter as a result of that initiative? Two, you talked about in the last couple of quarters how RoHS had diverted your engineering talent. Presumably now those guys have been redeployed and can work on some of the cost-cutting initiatives you need. Can you update us how that has gone?

Bill Nuti

I'll start in a reverse. We had a little bit of RoHS hangover in Q3, not much. Most of it really hit us in Q2. Yes, the resources that were entirely focused on the RoHS challenge that we and a lot of other companies had are now being redeployed to focus on our cost cutting and frankly, our competitive cost structure campaign. We have got a lot of work to do there, and I think a lot of cost improvement to harvest going into 2007.

So I don't want to leave you without good hope that we have a plan that could harvest some pretty decent cost reductions going into 2007. As always, it is down to execution. But let me be clear, we are focused on it and we are holding people accountable to driving it.

Reik Reed - Robert Baird

Okay. And if I could just ask one question on the retail side. You had mentioned your comments, Bill, that that environment is a little bit more stable. And yet you are lowering your outlook a little bit there. Can you talk a little bit about the puts and takes of what you are seeing in the retail space? And why you say you are seeing a little bit more stability?

Can you also comment, just on your channel strategy, now that you have had a little bit more than a year to be there you have historically been a little bit more of an indirect eye whereas NCR has been a little bit more direct. Do you see opportunities of using the channel a little bit longer term?

Bill Nuti

Yes in our retail automation business what we are finding is self-service technologies areas, self-checkout is one of the key areas in retail and is growing fairly well for us, where the core point-of-sale business has slowed down. The core point-of-sale business slowed down for two reasons. One, just digestion of point-of-sale applications in the market for the large retailers. Two, throughout the year this year its been fairly cyclical in terms of ups and downs in retail on CapEx because of the economic environment. That being said, we are very pleased with the self-service growth.

The other point I would make on indirect versus direct, a part of the reason why – well let me say it this way. We can possibly grow faster with a more balanced go to market approach, direct and indirect. A couple of hundred of our customers generate the vast majority our revenue today. We are focused strategically on widening the aperture of the number of customers we sell to by going down market. We are working towards a strategy where we will be introducing the indirect channel as a stronger part of our go to market. That's going to take time.

As you well know, when you are balancing go to market and you are rebuilding your channel, particularly in our case, because we are rebuilding our channel in the retail space, it could be two years of hard work and heavy lifting before you see results. I would like to see it sooner, but we have got a plan to go do that. We have to map that to a set of products and solutions we can also bring to market.

On the R&D side we are working towards packaged solutions that we can take down market through large distributors and a broad channel. What I would say though, is again, it is going to take a little bit of time.

Peter Bocian

And one other point. You are right, we did move the guidance about a point which is about $8 million for the year. The good news within that is we were over 20% self-service last year; expect to get to 33%, one-third of the business next year. We will make a good step between that 20% and that 33% in 2006.

So I think the focus on changing the mix is playing out like we planned. Just about an $8 million movement in the top line outlook to outlook.

Reik Reed - Robert Baird

Great. Thanks a lot.

Operator

Your next question comes from Matt Summerville.

Matt Summerville – Keybanc

Just on the ATM business again, to follow-up to some of his questions, are we talking about a couple of transactions with a couple of banks or is this more of a broad brush across the Americas region, if you will? And then, is it a matter of banks not wanting to spend money this year or banks are still getting ready to roll these things out?

Bill Nuti

It really does come down to a couple of large transactions for us, in terms of the change in our guidance on the top line. It is not that they don't have the money or want to spend the money. In some cases, we continue to move forward with deposit and that program itself will roll into '07. Key customers rolling out deposits continue to be very excited about the technology and consumer acceptance.

In all of those cases, I think the revenue could come back to us in '07. We are going to give you obviously guidance in '07 in January in terms of what we think for this business. Deposit, of course, will play an important role into the top line and bottom line performance we see.

The key issue with deposit, from my point of view, is not as much the front end ATM device as much as it is a combination of, we continue to mature that technology in the back end, the back office just not being ready. So we would love to go faster on deposit, but the back office and some of the changes that are taking place process-wise in the banks are slowing it down a little bit. That really is the key issue.

Matt Summerville – Keybanc

I mean, overall, based on what you are hearing from banks both the large financial institutions in the U.S. and those serving the community bank market, would you say that the banks are, or you, after what you have heard, are more or less upbeat on the whole Check 21 phenomenon?

Bill Nuti

Well, they are more upbeat on automated deposit at the front end because what we are seeing is improved consumer acceptance. You know, everybody has those days where you run into the office and the combination of things that you are pulling together in the bank to make Check 21 work can be very, very frustrating. So on any given day you can talk to a customer and they are frustrated because of the amount of work and the number of things that they are doing to pull Check 21 together.

But generally, generally across the board customers are excited. As far as we can see about the impact deposit automation is having on the business in terms of low value transactions coming out of the store and out to the ATM channel and the impact that has on their profitability and also customer acceptance in the market.

Matt Summerville – Keybanc

A question on Teradata. Are there any verticals which you serve right now that are showing any troubling signs or any that are perhaps surprisingly strong? Can you just talk about the overall sales cycle funnel: velocity, average deal size, how those metrics are trending?

Bill Nuti

On the vertical markets I mentioned this on the last call and not a lot has changed. We are more challenged in the U.S. this year on the retail front. Partly that's due to scale. We have such a tremendous install base in Teradata in retail as well. Some of the other dynamics around retail, as I talked earlier, this notion of the cyclical economy impact on how they have been spending.

We have been very pleased with financial services in terms of Teradata's traction in financial services as well as in telco. I have to say, in the telecommunications space where there is lots of consolidation the team has done a fine job in terms of keeping up pace. We are beginning to see good traction in manufacturing in the U.S. and around the world after a long effort of working hard towards getting some traction there.

Turning my attention to pipeline activity, what I would say is that the activity level remains good and remains fairly robust for Teradata as we’re looking out, so I'm encouraged with the funnel activity, the sales activity on a global basis and I would say last quarter to this quarter no change in terms of my general feeling there. I think the activity level is good.

Matt Summerville – Keybanc

Just to switch back to ATMs, knowing what you know today would you say your visibility into 2007 in the Americas is better or worse or the same?

Bill Nuti

I would say it is a little better because we are starting to get a sense of it how deposit is going to flow throughout the year. I would like it to be better but it is a little bit better. That's the way I describe it.

Matt Summerville – Keybanc

Okay. Thank you.

Operator

Your next question comes from Richard Farmer - Merrill Lynch.

Richard Farmer - Merrill Lynch

Thank you. Bill if I could first, just a follow-up on Teradata and I have some others. For the 5% growth in the third quarter on a tough compare, is a reasonably healthy result. On the other hand, looking on a rolling four quarter basis, the business decelerated to 2%; or on a third quarter year-to-date basis it looks like around 3% versus last year.

I understand you are still looking for 5% to 7% growth for the year, but what gives you the confidence that this business is going to reaccelerate going forward and what should investors really be thinking about as a reasonable long run, growth expectation for Teradata? I have some follow-ups as well, please.

Bill Nuti

On the Teradata front, I'll let Pete answer the guidance question for you in terms of the longer term which is what you should expect. I'll answer the question on what gives me confidence going into Q4.

The first thing of course is forecast from the business in terms of what we get from our business leaders and vetting that out. Also activity; I spent a lot of time in the field as you know, Richard, with customers and I just came off the partners conference where I spent three days with customers and partners . Obviously during those sessions I ask a lot of questions around -- basically the same questions of them in terms of what their spending is going to be and why it is what it is going to be. Not just in Q4 but going into next year in the business intelligence space, including that of date warehousing.

I like the activity level. I think the activity level in terms of what we have going on out there gives us an opportunity to achieve the lower end of the 5% to 7%. There is no doubt Q4 is going to have to be a big quarter for Teradata. There is no doubt, but I think they are up to the task and we are certainly going to work our tail off to get there.

Peter Bocian

Your points are valid, Richard. We are about 3% growth year-to-date. I would say aside from some movement between Q1 and Q2 it is pretty much what we thought. There's been some foreign exchange headwind for the first couple of quarters that flips in Q4. We had a softer, slower Q4 in 2005 so I don't want to call it an easy compare any time you are talking $400 million in a quarter. But relatively speaking, I think we caught up in Q2, we did well enough in Q3 against the tough compare to position ourselves for being right where we thought we would be which is we needed a big Q4 to close out the year.

Then I go to Bill's point which says, you look at the pot and you start talking deals inside of high level analytics and there is a good pot there for Q4 to go get this done. So we need to go execute.

Then you move forward from that and to me it is no different than we said in San Diego earlier this year. We expect this business to be 7% to 9% revenue growth. High single-digits kind of growth as we move forward.

So you are right, we have a Q4 that has to grow double-digits to close out, to get into the range. That's what we are focused on doing. The only point I would make is, it has played out like we expected as we started the year and said we would start out slower and then ramp through the year.

So that said, the Teradata team and we as a company need to deliver Q4.

Richard Farmer - Merrill Lynch

Okay. Thank you. On the ATM business, last quarter Bill, I think you mentioned there was encouraging signs in the ATM pricing environment. This quarter, did those signs translate into real better pricing behavior in the third quarter? How do you expect pricing to evolve in the next couple of quarters?

Bill Nuti

I think the pricing environment is still moderating in the market. I would call it erosion is just moderating right now. Depending upon where you are in the world however, it could be a different picture, Richard. I still see aggressive pricing behavior in the emerging markets, whether you are talking Eastern Europe or India. Those would be two countries where we continue to see aggressive pricing. But the pricing environment so far in '06 is better than '05. That's for sure.

Richard Farmer - Merrill Lynch

You mentioned that CapEx was up because of real estate actions and some additions to capitalized software. I am just wondering if you might provide a little bit more color on both of those? Particularly on the software, what's driving that? I'm assuming that's not changes in accounting assumptions. It may be a special project in Teradata, but basically just hoping to understand that a little bit better. Thank you.

Peter Bocian

Richard as we came into this year, what I tried to communicate was that last year was probably lighter and we expected some flow into this year. So these numbers, in general, are really not different from where we started the year. When you look at the breakout we would move re-workable parts up into the inventory section, so we are really talking about PP&E and capitalized software.

On the capitalized software, it is both a combination of investments in the self-service side of retail and Teradata. So think of it as it goes on the balance sheet because you are going to get value for it over the longer term as opposed to expensing it. So it is where we want to make investments is the way I characterize it.

The real estate initiatives are really linked to overall cost takeouts, so it is some element of investment that then reduces our run rate and our expense going forward. I think we have been pretty good at having that show up.

So really not anything that new and (b) the investments in the places you would expect and you would want us to invest. In the real estate, think of it as balancing capital expenditures with operating run rates for the better operating answer for the company.

Richard Farmer - Merrill Lynch

Okay, thanks very much.

Operator

Your next question comes from Kartik Mehta – FTN Midwest.

Kartik Mehta – FTN Midwest

Thank you. Good morning. Bill, I wanted to ask you about the data warehousing margins or maybe Pete, this is a better question for you. I'm not sure. As you look at that business can you talk about what the breakeven is now and maybe what the incremental margins are? I am assuming this quarter margins were impacted by all the investments you made.

Peter Bocian

Yes, I think first of all this quarter has the mix of hardware software, it also has the partners conference as well as the investments we make. I think we held in the 20% range that we have been doing on a consistent basis here. I believe since the beginning of '05 so there is really, I don't have a big reaction to Q3 one way or the other.

We are tracking to the 21% to 22% for the year. That includes the incremental investments that we are making in the demand creation in R&D. It is really as expected. You get a little volatility from customer A versus customer B. Software content, EMC versus LSI kind of storage; but in general, we are tracking. It is what we expected. Q3 would have something in it like a partners conference cost. Incremental to the demand creation in R&D, that could move it a little bit. But in general we delivered 20%. We are a little bit shy of 21% for the year-to-date. We have got a big revenue quarter expected in Q4.

Kartik Mehta – FTN Midwest

So the Data Warehousing business Pete, I think you said long-term growth rate looked like 7% to 9% on the top line. Do you think this is a business that is going to be lumpy in a sense that some years we will have 12%, some years we will have 6%? But on average it is 7% to 9%? Or is this a business that can consistently grow 7% to 9% with the base you have now?

Peter Bocian

Yes I think there is going to be some element of lumpiness with us for a while. We have had cases of that where you saw it last year in Q3 and this year in Q1. So I think the good news is it is a $1.5 billion business. It still has some lumpiness. So our job is to navigate through that, understand it and over time the thing we believe will normalize to the 7% to 9% could one year be 10% and the next year be 6%, maybe.

But I believe it is more as you get bigger, there should be less volatility. That said, there still are some big deals. There are major customers that count on this technology to deliver to their customers. So that's going to happen. And that's where we are.

Bill Nuti

The only thing I would add is a $15 million deal can swing growth by a point. In any given quarter we could have a couple of handfuls of $15 million deals that we are out there trying to close. So to your point, yes we could see some lumpiness and in fact we have. If you go back to 2003 and look at 2003 where we had a poor year in terms of growth, 2004 was a solid year. So was '05; '06 was a kind of mediocre year in terms of growth. So at a $1.5 billion, $15 million can move you one point in either direction. So until we get larger scale on the top line, it is a little bit volatile.

Kartik Mehta – FTN Midwest

No I understand that. I guess I wanted clarification that it is not easy just to model 7% to 9% over the next three years. It might be 12%, might be 6%. It might be 10%. So in aggregate it will be 7% to 9%.

Bill Nuti

Yes that's the right way to look at it.

Kartik Mehta – FTN Midwest

And last question on data warehousing, Bill. Can you talk about what percentage of the business now is international? It sounds like you are having success in some of the third world countries and also Europe. So what percentage of business now on data warehousing is international?

Bill Nuti

Because we don't give out the specific percentages what I would say is we are beginning to see better growth in Europe, Europe is picking up a bit for us. And in Asia we continue to see some growth outside of Japan as well. So the international markets in general are beginning to pick up. Teradata tends to do very well. It is a technology in markets where competition between companies becomes more and more of an issue, of course, because this technology aids companies in driving their competitive advantage.

So in the U.S. where there is a tremendous amount of competition, you find the business to be fairly robust. Now we are seeing some of that in Europe, particularly in the Western European countries. In Asia, again outside of Japan, I think we are seeing more solid growth.

China, in the future, could be a great market for us, particularly as competition heats up in China as well. So I think what I would rather say to the question s yes, international is getting a little bit better. U.S. continues to be a real strong growth engine for us.

Peter Bocian

The way I characterize it, we give out the mix of regional view by the company. Clearly we have talked about before that Teradata has started more of a U.S., Americas-based. I would say over time it is gravitating more towards the norm of the company relative to mix.

Bill's point about the different dynamics in the different markets relative to competition and regulation and so forth, move them at somewhat different pace. But we are moving, we are getting better international representation which over time will blend the mix more towards the NCR mix.

Kartik Mehta – FTN Midwest

And then last question, is there a big difference from a margin perspective for data warehousing, international and U.S.?

Bill Nuti

No there is not Kartik.

Kartik Mehta – FTN Midwest

Perfect. Thank you very much.

Bill Nuti

Thank you.

Operator

Your next question comes from Katie Huberty - Morgan Stanley.

Katie Huberty - Morgan Stanley

Hi guys. I just want to go back to the ATM business quickly. If the U.S. deposit upgrades doesn't come through at the rate you expect in 2007, what option do you have to cut North America manufacturing capacity to manage the bottom line?

Bill Nuti

We are going to certainly, next year Katie, you will see us adjust for the realities of our operational cost structure that's point 1. Point 2, I would say that we will have more flexibility going into '07 on the operational/manufacturing side than we did in '06. So I can't right now predict or tell you what I think deposits going to do in '07. If you want to pin me down to an answer I would say it is probably slowing or moderating a little bit more than it is speeding up.

But then again, you know, this market, I'm not yet ready to give you guidance on '07. I would just say that what you should hold us accountable to is to working vigorously on our cost structure in total in manufacturing going into next year.

Katie Huberty - Morgan Stanley

So it is still fair to think about margins coming up from the 12% level despite the increasing international mix?

Peter Bocian

Yes. Absolutely. The way I would look at it is that the 12%, my belief is a low point for us. We have got the opportunity, whether it is the Budapest Hungary facility, whether it is more alignment with each regional manufacturing facility to its relative volume. And then the deposit relative mix on what gets bought. So I think we have got a number of levers that will improve it from the 12% and we will come out with that guidance in January.

Certainly your point is it will be better if deposit is faster than slower but we will definitely improve from those margins. My view is we will definitely be able to grow as we look into next year. We will come back with the numbers in January.

Operator

Your next question comes from David Dillinger – Merger Market.

David Dillinger – Merger Market

Good morning. I was wondering, Bill, since you reported having cash and assets of more than $750 million, besides buying back shares, might you have some other uses of the cash? Perhaps for acquiring other things or things that might strengthen your software and other capabilities especially in Teradata?

Bill Nuti

We are going to continue to look at smaller acquisitions to augment, particularly in Teradata. The opportunity to add, for example, new data dimensions to our current portfolio. Whether those data dimensions are in areas such as unstructured data, unstructured text, geospatial, RFID, and otherwise. There are a number of areas we are focused on. Additionally small acquisitions continue to roll up, an opportunity to lead in this new self-service area that we are increasing more optimistic about long-term. We will certainly continue to use our cash in that way on a go-forward basis to drive growth.

Operator

Your next question comes from Matt Summerville.

Matt Summerville – Keybanc

Two follow-up questions. The margin expansion on a sequential basis in ATMs from Q3 to Q4, obviously within the realm of your guidance several hundred basis points. Is that more of a seasonal uplift or do you start to get the benefits from Hungary beginning in the fourth quarter? Staying on the topic of it Hungary where are you with ramping that second line and do you have room for more capacity beyond that?

Peter Bocian

Yes I think, you know, the sequential improvement and you can do the reverse math and figure out what we need to do to get 12% from the year, I think we are at about 9% year-to-date, is a number of things. We will get benefits from our cost take-out initiatives starting inclusive of some volume out of Budapest. We will get benefits from scale. We typically get a number of professional services, execution of those milestones and deliverables happening in Q4. So I think as we look through it we have got the opportunity clearly to get to the 12% and that's what we are driving to.

I wouldn't characterize the Budapest as the huge player but clearly every unit you build there is a lower cost unit than you had previously. So I think Bill is going to give you an update on the factory, but in general it is becoming a bigger part of the improvement. But the Q4 and delivering this year is probably four or five different variables coming together for us.

Bill Nuti

And just in terms of a quick update on Budapest it is going well. We continue to ramp, we did add the second line. The second line is up and running and certainly over time there is more capacity. We will add, and can and will add to Budapest.

Matt Summerville – Keybanc

My other question is, on the ATM piece of the customer services segment, 13% growth, how would you characterize your capture rates now versus where they bottomed? Can you give some sort of rough quantification there?

Bill Nuti

What I would say is they are better. They are not where we believe they can be, but the focus in the field is significantly better; the delivery of service itself from a customer services perspective is better, and I'm getting better reports from customers. We are not perfect.

On the attach rate side of things, what I'm seeing is our sales force out there really talking about the solution, inclusive of hardware, software, services -- and not just break/fix services now, Matt, but also managed services. For example, incident management where we are managing incidents for customers where they buy a help desk function from you and otherwise.

We also have some new technology that we continue to introduce that improves remote management of ATMs to drive higher availability and, frankly, provides our customers with a lot more visibility to what's going on in the ATM channel so they themselves also can make productive process changes.

So we are making incrementally better steps in product and service delivery. Our sales force is a bit more focused but our attach rates have a ways to go before Pete and I are excited about them.

Peter Bocian

I think we had talked before when we started this journey kind of in the 60s relative to capture rate. We said people that do it well are in the 80s. There is always going to be some element of channel that does the service. Third party partners, et cetera. I would say we are now in the 70s.

So it says we are getting traction. But you can see that in the revenue. We will never be above 80 because we go into markets and as we enter them we have a third party as opposed to build out a whole service force ourselves.

But I think we are making traction. It is showing up in the revenue. And really, a lot of the other initiatives are helping the profitability of customer services as we believe the ATM business is much more linked with the Customer Services business around total view of product and service and driving margins. So we are getting traction. We still have opportunity for improvement.

Bill Nuti

Yes just one more point for you Matt, because I think it is an important point to make. We have done a real good job in the last six to 12 months of capturing services on competitive products. Our competitors ATMs. We are servicing more of our competitor ATMs now than we certainly did six months ago or 12 months ago.

Matt Summerville – Keybanc

One more on service. Is there any more deliberate revenue attrition that you would envision for 2007 or do you think as we move into the new year, do you have the right balance between third party and non-third party?

Bill, back to you for more of a bigger picture question. You have been with the company over a year now. At what point do you plan on talking about your long-term strategy for NCR?

Peter Bocian

Matt on the customer services I think Q2 was a pivotal point for us in terms of enough traction out of the NCR-branded products to offset the erosion. I think you are aware, having watched our performance for the last couple of years that we tended to have the erosion much bigger than we could outpace with our own revenue. We really passed that point in Q2, Q3 again.

So as we look forward, I'm at the point where there could be some movement around the third party but we should have enough initiatives in our own space to offset it and that should be minimal. I expect we have plateaued and we should be able to grow going forward with a healthier mix.

I'm not quite answering you, will there be some minor attrition on the third party? Could be as we continue to work those areas. But it won't be major and I don't expect it that the whole Customer Services will go down. I think we have plateaued and we will go up from here.

Bill Nuti

Matt on the longer term vision, my first priority, as much as I wanted to jump in, and in my first 100 days in the company come out with the vision for the company. I inherited a plan that I needed to see through. I'm proud that this team has successfully seen that plan through and I was not going to divert the attention from the execution of what was in place as much as a new CEO might like to do that. We needed to drive that. That was, if you remember one of my comments I made last year when I came on board.

The second was really getting my arms around where we were going to take the company in the future and frankly I will be talking to all of you about that probably towards the latter part of this year as we go into next year.

Right now we are real focused on executing in Q4 and my sense is while I really can't talk about that today, there will be some information coming to you downstream.

Matt Summerville – Keybanc

Just to verify, you said this will be discussed before year end or as part of the fourth quarter earnings release?

Bill Nuti

We are not going to talk about it today Matt. I know you guys were lusting for information on this and the future, I appreciate that. But we will get back to you on that.

Operator

Your next question comes from Reik Read - Robert Baird.

Reik Reed - Robert Baird

Two follow-up questions. Pete just a question on the inventory. It was up 6% sequentially. The product revenue was basically down 1% sequentially. Can you comment on that?

Bill, a quick one for you. I know it is small, the RFID unit you guys have, but it sounds like you have reorganized that. Can you talk about why you have reorganized that and what you are seeing in the marketplace? Thanks.

Peter Bocian

On the inventory there is going to be some sequential build as you get ready for a Q4. But I would say we have an opportunity to do better in the self-service inventory space and we expect that to improve in Q4.

In the other area that we think we have an opportunity for improvement is in the parts area within the customer services, which was part of the reason why we moved to the different accounting treatment as inventory in Q2 because it gives you a much better focus and ability to manage the parts. So we are having much better, healthier discussions around parts that can be replaced, used in the machine, et cetera.

So net is, you would expect some sequential, we are probably higher than I would like in the self-service and parts area for customer services. The teams recognize and are working on it so it is a mix of, I would like to be a little better but some of it is a normal Q4 build.

Bill Nuti

And with regard to RFID like any company you have a limited amount of resources and you have to apply it to where I think you are going to get the greatest bang for your buck and you also have to recognize the competencies internally in your company. While I personally remain excited about the prospects for RFID technology going forward, we needed to make some decisions in terms of how we were going to use our resources going forward into 2007.

Frankly, Reik I just could not see an opportunity for RFID systems integration because that was one of the areas we were interested in looking at in a way that was going to add meaningful revenue to the company's top line going into next year; and if it did at what profitability?

So we decided to cut back the team a bit. We are certainly not out of the RFID business per se, obviously RFID is going to be important to Teradata as new data dimensions are added to the Teradata Data Warehouse. We have a terrific software technology and ID velocity, we are very excited about what ID velocity can do in the market in helping company's extract the value out of RF ID. We are going to continue to run did down that path. Outside of NCR, RFID continues to gain traction in retail.

Another area I've watched come up is asset management. RFID for asset management. I think you are beginning to see even a couple of CPGs embrace it. But from the point of view of becoming a systems integrator for RFID it is not the right time for NCR.

I just want to say thank you to everybody for joining us today and we look forward to talking to you again in the January timeframe. Take care.

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