Apr 23, 2009
Executives
Gavin Bell – Investor Relations Bill Nuti - Chairman and Chief Executive Officer Tony Massetti – Chief Financial Officer John Bruno – Executive Vice President, Industry Solutions
Analysts
Katie Huberty - Morgan Stanley Reik Read - Robert W. Baird Bennett Notman – Davenport & Company Gil Luria – Wedbush [Ajit Tay ] – No Company Given Matt Summerville – KeyBanc
Operator
(Operator Instructions) I will now turn the call over to your conference host this morning, Mr. Gavin Bell.
Sir you may begin.
Gavin Bell
Thanks and good morning everyone. Thanks to all of you for joining us for our first quarter 2009 earnings call.
Bill Nuti, NCR's Chairman and CEO will lead our conference call this morning. I will turn the call over to Bill in just a moment.
Our discussion today includes forecasts and other information that are considered forward-looking statements. While these statements reflect our current outlook, they are subject to a number of risks and uncertainties that could cause actual results to vary materially.
These risk factors are described in NCR's periodic filings with the SEC and our annual report to stockholders. On today's call we will also be discussing certain non-GAAP financial information such as free cash flow and results excluding the impact of pension and other 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, www.NCR.com.
For those listening to the replay of this call, please keep in mind that the information discussed is as of April 23, 2009 and 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. I will now turn the call over to Bill.
Bill Nuti
Thank you Gavin. Good morning and thanks to all of you for joining us today for our 2009 earnings call for the first quarter.
I have asked John Bruno, our Executive Vice President of NCR’s Industry Solutions Group to join me this morning along with Tony Massetti, NCR’s CFO. I will begin the discussion this morning by taking you through the results for the first quarter and then I will turn it over to John who will walk you through our decision to invest in the high growth, self-service entertainment industry.
Tony will then follow John and go through the financials in some detail, update our 2009 outlook and then we will open up the call for questions. Over the last several months there is no secret here, we have been commenting as all companies have frankly on the severity of the global economic downturn and what all of us have been faced with.
While the economy continues to be challenging and we are generally disappointed with our first quarter results there were several things that have gone well for the company and things that I think pose a very, very promising future for NCR. First of all, we significantly reduced our operating expenses compared to the first quarter of last year.
Operating expenses were down 14% year-over-year consistent with the revenue decline. We strongly feel this continues to help us create leverage in our cost structure and our future results will benefit as a result of this as the business climate improves.
We committed to further investment in the entertainment vertical which we strongly believe will deliver great value to our shareholders over time. We received revised guidance with respect to our pension cash funding requirements in 2010, effectively lowering our estimated cash contribution by $80-100 million in 2010.
We generated positive free cash flow in the first quarter and closed the quarter with a strong balance sheet and improved cash position. Finally, I was very pleased with our working capital performance despite the revenue downturn of 15% as the team continues to do a good job of blocking and tackling in the areas of accounts receivable and inventory management.
Although, as I said there were bright spots for the company in the quarter let me be clear that the team and I have very high expectations of ourselves even in a difficult market environment. It is fair to say we are disappointed with these results.
Overall for the quarter revenue came in at $1.01 billion that is down 15% from a year ago. About five percentage points of that variance was currency.
So on a constant currency basis revenue was down 10%. Our NPOI was approximately $28 million compared to $55 million in the prior year as lower revenue reduced our operating leverage.
This performance, while disappointing, reflects the combined impact of the economic challenges and comparisons to a very strong performance in the first half of last year where revenue was up 19%. Through accelerated cost and expense reduction actions we can reduce our operating expense excluding pension expense and special items by, as I said earlier, 14% over prior year levels and we are making very good progress in implementing the process improvement initiatives that will yield larger benefits in both gross margins and operating margins as we move throughout the course of the year.
Each of our geographic regions was impacted by the overall downturn in the global economy. Let’s talk about a few.
The Americas segment revenue decreased 6% during the first quarter of 2009 as compared to the first quarter of 2008. Foreign currency fluctuations negatively impacted the quarter-over-quarter revenue comparison by 2%.
The decline in revenue was due to lower volumes in the U.S. primarily attributable to customers in the retail and hospitality industry who have been negatively affected by continued weakness in retail sales and the U.S.
macro economic environment. Gross margin was negatively impacted by lower volume and an unfavorable product mix in the U.S.
as compared to the first quarter of last year. The Europe, Middle East and Africa segment revenues declined 22% in the first quarter and included nine points of negative foreign currency impact.
The decrease in revenue was primarily driven by the reduction in product sales to customers in financial services and retail and hospitality industries especially in the United Kingdom and Eastern Europe. The decrease in sales was due to the global economic environment and the corresponding impact on capital spending.
Gross margin was negatively impacted by lower sales volumes that more than offset the cost savings achieved by our manufacturing and organizational realignment initiatives. Asia Pacific and Japan segment revenue fell 20% due to significant product sales declines in Japan and to a lesser extent weakness in Australia and India.
Revenue was negatively impacted by 5% from foreign currency translation. In Japan the current economic environment contributed to declines in sales to customers in both the financial services and retail and hospitality industries.
Gross margin was negatively impacted by lower sales volumes in the first quarter which more than offset cost savings from prior realignment actions. From a global and market standpoint many customers and companies in these markets we serve have pulled back on capital programs in the first part of this year opting to preserve cash in an uncertain environment.
This was most apparent in retail. If I were to pinpoint the biggest impact in our lack of operating leverage in the first quarter this would be it.
With lower volumes it is challenging to absorb the overhead in the short-term. We fully expect retail to remain challenged but we will continue to go after opportunities aggressively.
We are in a very strong product cycle position with our 5.0 Self-Check Out solution and the RealPOS 70xrt the most innovative point of sale solution in the market. We are selling smarter than we ever have as well.
Our work, for example with HEB, a 300 store grocery chain in Texas and Mexico is a great example. Retail chains are a capital challenge to be sure but they also know technology investment at the point of sale drives efficiencies and customer loyalty.
In the case of HEB, our advanced marketing solution professional service team worked closely with our customer’s IT group to develop promotions software, so this is a software win for us. We built a full scale lab to pilot and evaluate the product.
Effectively their IT group largely outsourced this work to our AMS Professional Services team demonstrating we can take our retail experience well beyond the point of sale to hardware. Capital investment by banks meanwhile is relatively solid with respect to NCR solutions.
This is predominately true of the large banks who are continuing to roll out the positive automation capability. We have talked about the trend.
Banks are refocused on their positions as deposit-taking institutions and NCR technology achieves the objective of that strategy. We help attract customers, we retain them and we deliver superior ROI for the banks.
We are also taking automation even further, announcing in Q1 our APTRA consumer passport offering where consumers will now be able to scan and deposit checks from home in an online bank environment. We have been asked a lot about the business environment in financial services and we continue to see a tiered effect in consumer behavior.
Large financial institutions have the capital and the imperative to invest in deposit automation. National and regional banks depending on their exposure to bad assets are being a bit more cautious.
As the nearest competitors to the mega banks that are increasingly encroaching on their turf, the pressure on them to compete is building. Mid sized banks are not standing still, however, and there are active pilots in place.
Purchase decisions are being made more slowly. As the financial and credit markets begin to recover, our opportunities should improve.
Looking beyond deposit automation, replacement cycle activity in markets in Europe continues albeit at a slower pace. While in under penetrated markets in areas like Europe, Middle East and Africa and Asia, ATM initial deployments continue to move forward at a slightly slower but reasonable pace.
In a number of these markets banks are well capitalized, often helped in part by government control. Growth has slowed in this macro environment to be sure but the underlying fundamentals driving ATM adoption remain firmly in place and I remain optimistic about the long-term.
The retail and banking sectors will continue to be challenged in 2009 but it is important to remember that sales of products and solutions into these verticals drive about half of NCR’s revenue. The balance is driven by customer service and to a lesser extent consumables with sales of product like paper rolls, labels and our two-sided thermal technology.
These are typically stable, annuity like revenue streams that lend important support to our outlook in 2009 and beyond. Speaking to the first quarter, customer services is performing well from an execution standpoint.
We continue to drive greater attach rates with ATM sales and continue to get more efficient operationally while seeing a tangible increase in customer satisfaction. I would also like to touch on our burgeoning efforts in consumer self-service across new verticals.
We continue to make important strides here, winning a deployment in Q1 of our mini kiosks with New York Presbyterian Hospital and announcing our acquisition just this week of TNR, a leader in movie rentals via self-service kiosk. TNR in which we have held a small stake since 2008 enables us to apply our transactional expertise to what is already a successful kiosk solution in the market place.
TNR has over 2,000 kiosks deployed in retail stores across the country. You have heard me say before that entertainment can be the most attractive of the new vertical opportunities we are pursuing.
In fact, industry analysts believe self-service transactions via entertainment kiosks can be a $1 billion business by the end of next year. Whether it is entertainment or healthcare or other verticals we are pursuing, our solutions drive the same kind of efficiency and customer loyalty benefits as our traditional retail and financial offerings.
This is proven in categories like airport check in and is fast becoming reality elsewhere. It is inevitable that self-service becomes a legitimate channel such as it has in banking across multiple industries and we continue to see examples of this in new markets such as transportation and DVD movie rental.
I will turn the call over to John in just a moment and ask him to take you through the exciting opportunity we have in the entertainment space in further detail. Before handing it off to John I will sum up the quarter by saying we have actually been aware and acutely aware for several months that we are operating in the most challenging environment of our lifetime.
We expected revenue to be weaker in the first half of the year but we have indicated that the second half of the year will be better than the first half. Even if economic recovery is slow, second half results will benefit from our additional cost reduction activities as we reshape NCR’s overall cost structure.
We are accelerating those activities and have also driven down SG&A in the near term. We are lean.
We are definitely efficient and we will continue to improve on that. As we move through the balance of 2009 we will continue to focus on the things we can control.
Namely, acceleration of our cost reduction efforts as I just mentioned. Our long-term goal is to have the industry’s lowest cost and most efficient cost structure.
In the near term we are focused on several key initiatives to drive down cost and expense including an across the board freeze in merit, travel restrictions and a continued effort to right-size our organization and reduce labor costs. We will press our competitive advantages in the global market place with our customers and our innovation.
NCR has a strong product portfolio that offers a compelling value proposition and we will continue to target R&D dollars and devote the appropriate resources to creating demand. We will continue to enhance our global services capability.
Our improved services positioning has driven higher attach rates and improved profitability. We will continue to drive our service capability which provides both a competitive advantage in winning customers as an attractive and stable revenue source for the company.
Finally, we will take advantage of our strong balance sheet when opportunities present themselves. The TNR acquisition and the investment John is about to talk about and elaborate on are great examples and demonstrate our financial wherewithal to invest in the right places at the right time to ride out the economic storm and to capitalize on opportunities to fill in key technology and vertical gaps.
Having said that, the outlook for the remainder of 2009 especially in retail has become more cautious from the prior view. Therefore, we are adjusting our full year guidance to reflect the continuing dislocation in the global economy and the financial implications of the entertainment portfolio investment.
As we move through the second quarter I would ask you to keep in mind what we have been saying. The first half of 2009 presents unique challenges for us.
We believe our body of work for the year will tell a good story about NCR’s ability to manage through this historic downturn and emerge an even more competitive and strong company with outstanding opportunities for growth and a leveraged P&L. With that I will turn the call over to John.
John?
John Bruno
Thanks Bill. Good morning everyone.
Based on a comprehensive analysis we prioritized our 2009 investment toward the entertainment vertical due to the immediate opportunity created by the impact of self-service kiosk technology on this industry. The time to act is now.
Entertainment represents the largest and closest industry adjacency to our existing markets and advances our self-service strategy. We believe that we have the opportunity to drive the entertainment line of business to become a legitimate third vertical at NCR.
We have sized the market opportunity and the data supports our view that entertainment is a $1 billion growth opportunity available to NCR. In the $8 billion U.S.
video rental market, rental kiosks currently represent about 6% of the total. What we are seeing is a channel shift from stores to DVD kiosks driven by the fundamental premise for self-service which is the customer proposition of value and convenience.
We expect this is going to accelerate the shift to DVD kiosks over time. We are excited about our partnership with Blockbuster to address this changing market dynamic.
Bill mentioned our acquisition of TNR Holdings a moment ago. TNR is the second largest operator of DVD kiosks in the U.S.
and the acquisition accelerates NCR’s entrance into the DVD operator model. It allows us to stimulate demand for our solutions offering.
TNR is a valuable asset in the DVD ISO landscape with excellent quality of locations and we will leverage their capabilities going forward. While the entertainment line of business is an attractive strategic opportunity we believe that in order to be competitive in the long-term we need to be a full service DVD ISO which will require capital outlay over the next three years.
A large DVD rental kiosk network is critical to develop a credible, competitive environment in the critical mass that is needed to effectively absorb overhead. Our plan is to deploy 30,000 units over the next several years and it will require significant capital outlay beginning this year with approximately $60 million.
Execution of a full-service operator model has the potential to generate more than $1 billion in annual revenue within the next five years with high teen’s margins. We expect the business to be profitable over the next 2-3 years.
With that I will ask Tony to talk to the Q1 results in more detail.
Tony Massetti
Thanks John. NCR’s total revenue from continuing operations in Q1 2009 was $1.01 billion, down 15% versus Q1 2008.
This includes a 5 point negative impact from currency translation. We reported a GAAP loss from continuing operations of $15 million or $0.09 per diluted share.
This compares to a GAAP income from continuing operations of $49 million or $0.28 per diluted share in Q1 2008. NCR’s results from continuing operations include special items in both periods.
In Q1 2009 there was a $5 million charge related to the impairment of one of our equity method investments or $3 million after tax which was fully offset by a $5 million or $3 million after tax benefit related to an insurance settlement related to the Fox River environmental matter. In Q1 2008 there was a $16 million gain or $0.07 per diluted share resulting from the sale of the Canadian manufacturing facility.
Excluding these items, non-GAAP diluted loss per share was $0.09 per share in Q1 2009 versus earnings of $0.21 per diluted share in Q1 2008. Pension expense was $38 million in Q1 2009 compared to $6 million in Q1 2008.
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 that reconciles our GAAP to non-GAAP results. The remainder of my comments exclude the impact of special items and pension expense.
Our Q1 2009 gross margin was 20.3% compared to 22.1% in the prior year period as a difficult economic environment offset the benefits from manufacturing realignment and continued emphasis on cost reduction initiatives. Operating expense excluding pension expense and special items was down 14% or $29 million versus Q1 2008 due to diligent focus on expense control in this environment.
Operating expense as a percentage of revenue was up only 20 basis points versus the prior year despite a soft revenue performance which demonstrates our ability to manage our cost structure to fit the operating environment. Please note on schedule B of this morning’s earnings press release SG&A in Q1 should be $146 million and R&D should be $31 million for a total of $177 million in Q1 2009.
These figures will be reflected in the 8K filed later today. Total company non-GAAP income from operations and NPOI was $28 million in the first quarter compared to $55 million in last year’s Q1.
Below the operating income line interest and other expenses were $5 million in Q1 2009 compared to income of $1 million in the prior year period. Turning to the balance sheet, cash on hand at 3/31/09 was $717 million.
Short-term debt balance was $301 million while long-term debt was $7 million. Approximately $26 million of Board authorization remains on our share repurchase plan with an additional $4 million available under the dilution offset program.
Moving to the cash flow statement, NCR generated $38 million of cash from operating activities in Q1 2009 versus $81 million in the prior year period. After investing $25 million in capital expenditures, we generated $32 million of free cash flow in the first quarter compared to $49 million in Q1 2008.
NCR defines free cash flow as cash from operations less capital expenditures for property, plant and equipment and additions to capitalized software. We continue to deliver good performance of working capital management.
I will conclude my prepared remarks by updating our guidance for full year 2009. We expect revenue in 2009 to decline in the range of 5% to 10% on a constant currency basis.
Based on average exchange rates in March this will translate to the top line being down in the range of 10% to 15% for the year. We expect non-pension operating income for NPOI to be in the range of $310-350 million for the year which includes an approximate $30 million impact from the entertainment investment.
We expect earnings per share in the range of $0.60 to $0.75 in 2009 which includes approximately $0.15 of dilution from the entertainment investment. Pension expense is estimated to be approximately $170 million in 2009, somewhat more heavily weighted towards the latter half of the year.
At the end of March the U.S. Treasury Department issued revised guides which impacts our expected pension cash contributions in the U.S.
We continue to expect to contribute $120 million to our global pension plan in 2009. Assuming that interest rates remain constant and 2009 asset returns are between +10% and -10% we now expect to contribute $120 million to $150 million for our global pension plans in 2010.
This is down from the previous estimate of $200-250 million for 2010. Our full year tax rate is expected to be approximately 25% and finally we expect free cash flow to be approximately $60-90 million in 2009 which includes the impact of the entertainment investment.
Given the revised estimates for 2010 pension cash contributions we remain highly confident in our ability to generate positive free cash flow in 2010. Now I will turn the call back over to Bill for closing comments.
Bill Nuti
Thank you Tony. NCR will continue to execute during this historic downturn in the macro economy.
The work NCR has done over the last several years and the continued work in front of us in both our core industries and our emerging entertainment opportunity is improving in a significant way the cash generation and earnings power of the company for the long-term. Despite limited near-term revenue visibility, difficult first half comparisons, pension commitments and the dislocations affecting our retail and financial end markets improving NCR’s long-term fundamentals define NCR’s opportunity as we preserve our long-term objectives.
We feel confident about those objectives and we also remain resolute in our efforts to steer the company through the current challenges towards this exciting future. Thank you again for listening today.
Now we will open it up to your questions.
Operator
(Operator Instructions) The first question comes from the line of Katie Huberty - Morgan Stanley.
Katie Huberty - Morgan Stanley
Bill, given you had expected the tough environment coming into the March quarter can you help us understand what the biggest incremental surprises were from March 11 to the end of the quarter that caused you to reduce the full-year guidance?
Bill Nuti
On the guidance I want to be clear what we did. There are two different impacts to guidance.
If you take the entertainment industry out of the equation we would have taken guidance down from what we said was in NPOI from $360-400 million to $340-380 million. So down a little bit on either end about $20 million there.
Entertainment impacts the NPOI guidance by another $30 million. Hence, the guidance of $310-350 million.
The entertainment investment will be about $30 million of NPOI in 2009. On the top line, it comes down to the last month of the quarter a difficult order environment.
The orders did not come in at the rate we expected in March. I got a little bit concerned with the backlog position based on the orders.
The backlog is okay. We have got over $900 million in backlog.
It is fairly solid. It is certainly not the backlog position we had in 2008 or 2007 when we were growing the top line in the high single digits but because we didn’t get the orders in we expected and the backlog didn’t grow to a level I was comfortable with I just felt it was prudent to take the guidance down a little bit on the NPOI line and on the top line.
Frankly, I am confident we have got the ability to continue to manage costs. We certainly are doing a nice job in the company on expenses but until we see the sales numbers start to pick up at a rate I am comfortable with I felt it was prudent to just take the guidance down a little bit.
Katie Huberty - Morgan Stanley
Was the backlog deterioration more on the retail side of the business versus the financial?
Bill Nuti
Retail is hurting us the most. Retail, particularly in the U.S.
is hurting us the most. Now we had an extraordinary 2008 in retail.
So the compares we are dealing against are just enormous. 19% year-over-year growth in Q1 last year in general and I think retail was up in the 20’s if I am not mistaken.
23% in Q1 last year. So that is one factor.
That being said, retail is very tight. Retailers are just crunching down on capital spending and they are continuing to push out the orders.
Now it is not the orders as much as it is also they are pushing out their previously procured roll outs. So they are all moving ahead with their roll outs.
We just continue to hear every three months or so, “You know what, we want those 500 terminals to be moved from these two weeks to those two weeks.” Unfortunately sometimes it moves it out of your quarter.
So we see push outs and we see the sales cycles are just very hard and very long in retail. They are probably going to be that way for the foreseeable future.
I think for the rest of 2009 and certainly their fiscal year leading into January. We will see how things go in the back half of the year when the comps get easier for us but generally the environment in retail is the toughest for us.
Katie Huberty - Morgan Stanley
Lastly, were there any either product or geo segments that actually surprised you on the up side? Maybe improved as you went through the quarter and heading into June?
Bill Nuti
There have been. China was a surprise on the up side.
We had a very solid quarter in China and parts of the Middle East and Africa were also very solid. They were the only two teams in the company that were up year-over-year.
Operator
The next question comes from Reik Read - Robert W. Baird.
Reik Read - Robert W. Baird
Bill, to the Blockbuster thing, they have said they want to put in 10,000 units by the end of 2010. Can you give us some sense as to what that time table might look like through the rest of this year and as you get into 2010?
What your confidence level is just given their condition and is the source of the incremental investment at least in the very near term associated to the Blockbuster or is it other opportunities you are seeing and can you talk a little bit about what those might be?
Bill Nuti
There are a couple of different applications, certainly the largest of which is NCR committing to become an independent services operator utilizing the Blockbuster brand, building Blockbuster stores in a box if you will and we have committed to building 10,000 units or a 10,000 unit footprint by June 2010. Yes, a significant amount of the investment that we are making in that is going to happen obviously in 2009 and going into 2010 which is why the guidance is reflecting that.
The network effect, however, we think we can create with that in coming quarters in 2010 and 2011 I think could be very, very exciting for the company given our reference competitor in this space is doing quite well. The network of 10,000 units we will see whether or not we can get there.
We are working hard to get there. We have committed to get there.
But at the end of the day it is going to come down to execution. If we don’t get there we are going to get awfully close to it by then.
I can tell you that. We have got a lot of work to do.
That is a tremendous amount of work on a weekly basis to roll out units. The good news is that the adjacent verticals we are going to put these units in are our vertical markets whether it is retail and in some cases you are going to see these units, these stores in a box be put in a variety of different vertical markets besides just retail stores.
You will find them in train stations, travel boarding areas, University campuses, corporate campuses where they do extremely well on corporate campuses, etc. What I will do is I will just turn it over to John to see if he wants to add any more color.
John Bruno
The only thing I would add is as Bill mentioned there are two target areas. One would be net new opportunities to sell into in which we already have an existing sales force and good customer relationships.
Then the other one is expanding the existing footprint as we acquired TNR that is available or was available to them contractually now that we have the capital to go after those locations. So if I take a look at 2009 we can say about 1/3 of them is our target as we approach the end of this year but the remaining portion of the 10,000 referring to being in 2010 and the only rest there really is the latter month, the December month and so forth where the largest target is grocery retailers and so forth.
We just can’t fully predict can we achieve the kind of roll outs during that time frame because the retailers might not want us to in that month. So that is the only variable that we are still working towards to close on.
Reik Read - Robert W. Baird
John, if I could also follow-up with you on your comment that you basically have to invest to become a DVD ISO. Can you talk about what needs to happen between now and the next milestone date to build up that infrastructure?
John Bruno
The good news is we just completed the last remaining part of that gap through our acquisition. So in order to be a full service, obviously the harder element is being the hardware/software services piece which we had and now the merchandiser cost center pieces and deployment and the things necessary to actually operate them.
So the combination of what we have already built as a company to sell into this industry and the combination of TNR that has already been an operator, we believe that we have closed that gap to a very large extent.
Reik Read - Robert W. Baird
Broadening out the retail discussion, you said that things will be weak for the rest of the year. Given that we are getting longer in the tooth versus the last up tick cycle does that suggest that the same kind of move along the bottom for the rest of the year or do you still see another leg down?
Bill Nuti
No, I think things move along the bottom for the rest of the year. Largely the benefit at least internally will be comps.
Externally it will be just what we are seeing in the market. Some retailers, and I don’t want to get overly excited about this, some retailers are beginning to loosen their purse strings on some of their larger deployments recently but this is very recent.
Whether or not that is a short-term trend because the markets take another free fall or whether or not it is indicative of them seeing a bottom I don’t know yet. I have had multiple conversations with retail customers.
Some would argue they are beginning to feel a little bit better about the environment. Their stocks have been hammered.
Their comps have been hammered. Some of them don’t think there is another leg to go.
However, there is a camp that says you know what we are just very pragmatic about where we are. We don’t know where this is going to lead yet.
We don’t know if there is another leg down. We are going to keep our powder dry.
Now, three months ago or four months ago everyone was in the we think we are going to keep our powder dry camp. So whether that is a sign of things to come or not I don’t know.
Most of them have very little visibility into the future and most of the CEO’s I have talked to don’t really want to commit to where they are going to land in the back half of the year because they have been burned. So, that to me still tells me we need to be very conservative here at NCR.
Very cautious and when I see the last month of a quarter retail fall the way they did versus what we expected, it has to cause you to say you know what let’s take a step back and adjust your guidance a little bit based on the realities of what you saw versus what you are hearing.
Operator
The next question comes from Bennett Notman – Davenport & Company.
Bennett Notman – Davenport & Company
Can you just talk a little bit about what is Blockbuster’s role in the new relationship now that it sounds like you guys are going to own and operate the kiosks? What are the economics?
When do we start to see revenues flow in for you guys?
John Bruno
Basically we have a brand fee that we pay them. So we are using their brand and the license fee.
We are doing some rev share based on the performance of the model. So they are our go-to-market partner.
They are helping us on access to their catalog because they have a fantastic catalog for their stores and marketing and obviously assistance in understanding the customer dynamics by zip code and the buying behaviors. So if you think about it we are operating hardware and we are dealing with the services support and building the software support and then they are helping us on the branding, merchandising, etc.
Bennett Notman – Davenport & Company
So then the revenue flow is based on revenue split once everything is deployed?
John Bruno
Yes. There is a rev share and we take the top line and do a rev share.
Bill Nuti
NCR takes the top line. We do a rev share based on revenue per kiosk that escalates with revenue.
So there is a low percentage dip to kiosks, rev share low percentage for Blockbuster if the kiosk is not successful meaning it produces a low amount of revenue and there is a higher rev share if the kiosk produces higher revenue in the store. We would take the top line in that case both for today, rental, and in the future there is a model we are working on vis-a-vie DVD or digital download of movies that we will talk to you about at a future date.
Bennett Notman – Davenport & Company
The $60 million spend is that going to show up in R&D or SG&A or split between the two? How should we look at that?
Tony Massetti
It will be split between SG&A and R&D.
Bennett Notman – Davenport & Company
Your existing service organization, can they carry out the service on these kiosks or do you need to bring in new service personnel specifically for this operation? How does that work?
Bill Nuti
The majority of the services will be done by the current service organization in place that is with the advantages of this transaction for the company in terms of absorption of our people. These are electromechanical machines not unlike what we build for ATM’s and other types of devices.
One difference where we have had to acquire and as the case build up, in the consumer help desk which has been put in place to handle calls from consumers that might come in from locations where there is a kiosk in the field. This is a multi-channel solution which is you can actually from home vis a vie your web browser, fly into one of our kiosks and check its inventory.
You can reserve and rent your movie on line and if you have a question from home while you are on the web you can call the call center and there will be somebody there for you as well. Also the mobile device is going to be utilized in this multi-channel relationship with our kiosk where you will be SMS text messages as well as promotions and other things.
That particular capability is coming out this year.
Bennett Notman – Davenport & Company
Will we be picking up physical DVD’s that have been burned so there will be thousands of titles at the kiosks? Or do you have to stock the kiosks with actual movies that are out?
Bill Nuti
You stock the movies. So our kiosks, one of the advantages of NCR’s kiosks versus some of our competitors here is the capacity of these kiosks.
It nearly doubles that of the competition and you stock them with physical DVD’s. It is not a burning mechanism per se for the DVD.
One of our other kiosks actually stocked nearly ten times that of the competition.
Bennett Notman – Davenport & Company
On the pension expense for 2010, does the reduced cash contribution is that going to result in a reduced accrual for P&L purposes or is this just a change in the cash portion that wouldn’t impact 2010?
Tony Massetti
This just changes the funding requirement on the cash side of this for 2010. The expense stays the same.
Operator
The next question comes from Gil Luria – Wedbush.
Gil Luria – Wedbush
On the entertainment piece, originally when you announced the deal with Blockbuster it sounded like part of your plan was to try to sell some of these kiosks to retailers. It sounds like now the 30,000 deployment is going to be all NCR owned.
Is that correct?
Bill Nuti
That is correct. The change in business model, let me clarify, for Blockbuster specifically the business model change is we are going to be operator of the kiosks and we are basically utilizing their brand as a brand agreement with them.
Of course, as John mentioned they are taking on some responsibilities but we are the end-to-end provider of the total solution now at this juncture. So we actually get paid by the click if you will and there is a rev share on the click similar to an ATM ISO model if you will.
So that is the one major shift, one major change from selling. However, there are a whole host of other applications where we will be selling this technology to other retailers, other game manufacturers where we might actually sell the kit and provide services.
Then there are some companies who would like to buy the kit, brand it with their own brand, and then own and operate it themselves. So there will be customers who fall into both of those camps.
One example would be there is a very large retailer who is now testing this kit out in nearly 100 stores for buy-sell-trade applications where we are essentially putting in our hardware solution. They are using our services.
They are filling the machines with movies and games and what you are able to do is either buy the movie or the game in store and it reduces shrink by orders of magnitude. I don’t know if you are aware of this but DVD, movie or CD shrink and game shrink is the largest problem retailer’s face in terms of total shrink problems.
So it dramatically reduces shrink because you are moving DVD’s and CD’s from aisles into boxes. These boxes can be reached by the net.
They can be reached by your mobile phone. Before you get to the store you can browse, you can compare shop, you can watch trailers, you can check out games while you are in the store.
There is a very nice LCD display you can utilize to check out trailers and games before you buy. The box itself will make you an offer if you return the game or movie and make you an offer to buy it back for a certain price and therefore you can not just buy but you can sell and trade with the device.
It reduces shrink. It doesn’t cause you to have to find a check out clerk at the store and wait 15 minutes to get behind the glass and open up a lock and key to buy a game.
It helps free up the front end a bit in those retail stores. So those applications are certainly ones that there is a great deal of interest in and they would be purchase applications.
The DVD operator play, the 30,000 machines we are going to roll out over the next several years is strictly an operator play in North America, Western Europe, Japan and likely Australia are our targets for us.
Gil Luria – Wedbush
So you disclosed overall the impact from the investment in this vertical. Would you mind breaking out how much you paid for TNR and any metrics you can give us in terms of what revenue they have and if they are profitable or how profitable they are?
Tony Massetti
We are not providing that level of detail for our investments in terms of what we paid. As far as the revenue it is too early to say on revenue forecasts.
Bill Nuti
We have a little bit of work to do here on the revenue side. Suffice it to say I have very high expectations of this business.
We did not go into this business to take a $30 million drop on NPOI in 2009 without expecting return for the shareholders. I’ll be very clear.
Return for the shareholders is as immediately as we can get it. Long-term prospects of this business are huge for us.
You can go and look at our next referenced competitor in this space who is number one in share today and they have done a very nice job by the way and I have a lot of respect for them in terms of what they have been able to accomplish. However, I think they would agree and we would agree the market is tremendous and they are only in the United States today so the market is huge.
It is global. There is clearly a dislocation that has taken place in this market space in terms of how people rent movies.
It has clearly impacted our strategic partner and friend Blockbuster, but they are also the foresight and I give their CEO a lot of credit and their company a lot of credit that this was a very important strategic move that they needed to make and you can see they are also making a ton of other moves whether it be with TiVo or other companies. So they are doing very smart things and I think that is going to pay off for them.
This was certainly one where partnering with a company like NCR with our technology, being able to use our balance sheet and our scale to roll out a 30,000 store footprint around the world in this tremendous dislocation that is taking place in terms of the business model can be tremendous for both companies.
Gil Luria – Wedbush
It looks like you paid about $11 million for the 19% of equity when invested initially. Can we assume that you paid less than $40 million for the remainder?
Bill Nuti
Yes we did. We paid a lot less.
Gil Luria – Wedbush
On pensions you talked a little bit about a change in regulations that is going to reduce the cash flow need. How should we think about how much cash you are going to have to contribute over the next 7 years as we sit today with where the capital markets are today?
How much cash are you actually going to need to require to get within the regulatory requirements for funding your program?
Tony Massetti
We try to provide as much visibility on pension expense and funding requirements as we can. It is very difficult to predict what is going to happen beyond 2010 from a cash requirement due to we have 30+ pension plans and they are dependent on market equity returns and discount rates.
So I am hesitant to project out beyond the guidance that we have given which is 2010 cash funding requirement. We are pleased with the clarification from the Treasury Department as Bill mentioned.
It is $80 plus million of additional cash in 2010 which we can use to invest for shareholders.
Gil Luria – Wedbush
Asked differently, you are under-funded status as of your last K was $1.2 billion. Is that how much cash you are going to have to contribute over the next 7 years or is it a smaller portion of that?
Tony Massetti
It really depends. This latest change reduced that liability by $300 million from a cash standpoint.
But the skew also changes as well. So again it is very difficult to say.
There are many moving parts here.
Bill Nuti
This is good news, right. This is tremendous news for us in terms of cash requirements for 2010.
Number one, it gives the markets and NCR some time to recover which means the markets recover and the discount rates remain stable this is all good news for our pension in the go-forward years. If it doesn’t, we are trying to provide you with a model to give you a perspective of what could happen.
Getting nearly $100 million back in cash for 2010 was a tremendous news for us and we are hopeful it gives the markets time to stabilize and recover and then on the back end positively impact NCR’s pension obligations.
Operator
The next question comes from [Ajit Tay ] – No Company Given.
[Ajit Tay ] – No Company Given
Just trying to get some more color on the large consolidation in tier one banks in the U.S. Could you give us some color as to any changes in behavior you are seeing particularly when it comes to Washington Mutual and the [inaudible].
Bill Nuti
They are both moving along according to plan as far as we can see. We have been pleased with our level of participation and pleased with the level of satisfaction both of those large companies have with NCR.
I think both are on a very tight schedule as far as we can see and will probably both go into 2010 but both are also very dedicated to deposit automation. There is no question they are both dedicated to building a deposit friendly, envelope free network over the next several years and continuing to roll out the deposit automation and deposit friendly technology for many years to come as their “classic networks” which would be their older networks also need to be transitioned out from envelope to envelope free.
[Ajit Tay ] – No Company Given
What about in terms of their putting together two different businesses and two different platforms? Some of the integration would it require some rationalization of footprint?
Are you seeing any sort of decisions that have to be made at a technology level at the top that could create a pause? What kind of visibility do current contracts have with these folks?
Is it six months or a year?
Bill Nuti
I haven’t seen…what was the last point?
[Ajit Tay ] – No Company Given
Do current contracts or schedule they have, have you seen any change in that? How much of that is committed?
Bill Nuti
I have seen no pause. No change in behavior.
Both of them are racing to the finish line with deposit automation. There has been no perspective provided to us there is any significant change in the footprint.
There will be some reduction in footprint but it appears to be relatively small in general. It is one of the things that was the highlights for us at least in Q1 and will continue to be in forthcoming quarters with again the aggressive nature they are rolling out.
No, I have not seen a difference whatsoever.
[Ajit Tay ] – No Company Given
Looking at emerging markets, looking at the strength in the dollar do you see any change in your dynamics especially as far as pricing goes in penetrating emerging markets?
Bill Nuti
Pricing certainly got a little bit tighter in Q1 because of the nature of the economy. Everybody chasing a little bit less business.
I think that is a function of just people wanting to participate. Pricing was a piece of our 180 bips margin decline but it was really more volume based and more mix based.
Back directly to your question, not really. Certainly when the dollar goes it hurts us to some degree from a hop line perspective.
We have good hedging strategies and certainly it impacts us well on the expense line so it doesn’t have a major impact on the company. It helps one of our competitors.
There is no question it helps one of our competitors. We are much more geographically balanced I think than both of our other major ATM competitors but as you well know depending upon either one, one has a stronger presence in Europe and less in the U.S.
The other one is very strong in the U.S. and less overseas.
So, the impact on them would be a little bit different. On pricing though I haven’t seen the dollar exchange rate become the major issue.
I think you will see consistent margin declines probably with those other competitors in the quarter in light of volume pricing mix and some of the things that we have seen.
[Ajit Tay ] – No Company Given
Just looking at the healthcare opportunity, you have talked about entertainment being a significant opportunity for the company. What about healthcare?
What is going on over there? How would you characterize that opportunity relative to entertainment?
John Bruno
Great question. So, the interesting thing about healthcare is we are seeing greater interest from hospitals, physician groups, etc.
on the roll that self-service plays with our medi kiosk program which actually helps move lots of stuff that you see today on clipboards moved to a computer. Obviously clipboards to computer phenomenon in any industry drives a lot of efficiency.
They help with accuracy, etc. It is a pretty straight story.
What is really going on in 2009 is understanding the stimulus packages particularly in the U.S. as well as those elsewhere and how that is going to flow through in areas with socialized medicine and even in our case stimulus into the general community.
So we have pretty active engagement with out healthcare team as well as our government relations team in helping to understand that to help our customers shape how they can participate in that. From what I can see today, where those dollars flow, it seems to me to be more of a 2010 phenomenon than a 2009 phenomenon with a lot of the effort going into the shaping of it and how it is that people are going to participate in it in 2009.
That is what we see today.
[Ajit Tay ] – No Company Given
How would you size the current principle market of your current portfolio?
John Bruno
The addressable market?
[Ajit Tay ] – No Company Given
Yes.
John Bruno
That is a good question because I have not sized it with what we perceive to be how the effect of the stimulus package changes that market. That is a good question and I will have to follow-up with you on that.
Bill Nuti
The only other thing is for self-service, the applications we sell in healthcare there isn’t any third-party data. I have busted the chops of this team for two years to get me third-party data from any source I can and customer data on self-service technologies and what the addressable market for self-service is on a global basis, if not a regional basis.
The problem is it is just not a large enough market to have interested third-party companies provide that. That being said, the way I look at it is if every single hospital, every single major healthcare institution is a prospect of NCR to automate check in, to automate a whole host of other applications that are available to us in the hospital.
In the healthcare bill there is specifically a paragraph that talks about self-service and automation being important as it relates to e-Health. That is a positive.
I don’t know where that leads but with a full frontal effort on understanding as the stimulus gets rolled out, as hospitals become more interested are they prospective customers of ours.
John Bruno
And privacy protection.
Bill Nuti
And privacy protection. Every hospital is a prospect.
It is a great question. It is one we have to answer for ourselves but in light of the fact that we don’t have empirical data externally I am a fact based guy.
If you can’t find me a fact base set of trends and understand this industry then we have to view it as every hospital is a prospect of service, size and scope. By the way, the operator model we are rolling out in entertainment will eventually become a vehicle for us to roll out potential self-service operator applications in healthcare and other industries as well.
Operator
The next question comes from Matt Summerville – KeyBanc.
Matt Summerville – KeyBanc
How should we think of the pace of that $30 million hit to NPOI playing out as the year progresses? Then I was wondering Tony if you could clarify the delta in free cash flow guidance.
Is all of that related to this initiative?
Tony Massetti
The investment in entertainment will be pretty evenly distributed over the next three quarters, Q2, Q3 and Q4. So you can model it that way.
Then the free cash flow change in guidance we previously had guided $125-150. That is now down to $60-90 for 2009 and that is the result of the change in revenue in NPOI guidance, the $20 million Bill spoke about earlier and then the $30 million investment or $60 million investment, excuse me, in the entertainment space.
So that gets you to the $60-90 million free cash flow.
Matt Summerville – KeyBanc
Could you also comment, I think you hit on the tempo of orders in the retail business. Can you also talk about how ATM order tempo played out in Q1?
What are you seeing for the first two weeks of April?
Bill Nuti
ATM orders were light in Q1 but expected particularly given the year-over-year compares from our best quarter ever which was Q1 2008. The beginning of the quarter is okay.
It is only two weeks in. I think okay was the way I would describe it right now.
We are a little bit more upbeat for some sequential growth this quarter. We will see whether or not we get there.
We have a commitment to get there but I want to see it play out.
Matt Summerville – KeyBanc
As we think about cost savings it would be helpful, you talk about early 2008 being the starting point for this $200-250 million you are targeting through 2010. Based on your plans to accelerate some of that and in response to what is happening in your businesses I really think it would be helpful do you have a targeted number just for 2009 relative to 2008?
I guess what the win rate was for that in Q1 and how we should think about that as the year progresses.
Tony Massetti
We haven’t given any specific guidance by year. Certainly we ramped that or accelerated that cost reduction and expense reduction programs that we put in place in 2009 and pulled as much into the first half of 2009 as possible.
We haven’t really broken out how much of it the $200-250 million by year. I would say the majority of the cost expense savings is still in front of us.
I will say that. Over the next 6-8 quarters.
Bill Nuti
My only other comment would be despite the revenue challenges, one of the things that we are licking our chops over a bit is the leverage we are building into this cost structure. We have expenses now down significantly and we are going to take them down more in the forthcoming quarters and we believe that we are building significant leverage in the model.
A lot of the gross margin enhancement plays we are running here later this year into early 2010 hit later this year and early 2010. What you are seeing now is an acceleration of expense.
What you are going to see later is an acceleration of cost on the margin line. That is probably going to hit later this year and in 2010 and rolls out throughout 2010 kind of driving to fruition at the end of 2010.
So, good progress is being made. We certainly have the attention of everyone in the company.
I am pleased with people keeping their heads down and remaining focused through these turbulent times.
Matt Summerville – KeyBanc
Based on how you think about earnings building sequentially throughout the year, is there any reason that we should think or anything you are seeing in your business that would dictate otherwise? Should we think about building in the kind of normal seasonal pattern revenues that we normally would with Q2 being higher than Q1?
Q4 being the highest for the year and Q3 somewhere in between? Is that the right way to think about it?
Bill Nuti
That is exactly the way I would think about it. I think also consider compares.
Q2 last year was a 13% growth quarter while we are down to 3% I think in Q4 last year. 2-3 points.
I think the way you need to think about it is yes, a little bit more than Q1 in Q2. Q3 and Q4…you know Q4 is always the strongest quarter for the company.
That is the way I would think about it. By Q4 we will start to look a little smarter relative to the compares that we have now.
Matt Summerville – KeyBanc
You mentioned Bill in your prepared remarks that you introduced in the first quarter the ability to deposit checks remotely from say your home. I guess can you explain to me how that works with no hardware investment and I guess why that wouldn’t cannibalize anything from intelligent deposit?
Bill Nuti
It is interesting. This is a pretty exciting space.
We are not talking about it that much yet. Think about a scanner that is connected to your PC where from home if you have a check or two you can scan that check like you would at an ATM and there is software and application loaded on your PC obviously connected to your bank that allows you to very similarly than you would at home or an ATM deposit a check.
You do the same at home. Does it cannibalize the ATM?
I don’t think so because of the fact that there are still a very small proportion of the population utilizing intelligent deposit like applications. There are well over 30-35 billion checks a year that are still written in the United States.
If every one of us were to use an intelligent deposit application be it at home or on the go with an ATM gosh we would need a much larger ATM footprint even if there was a proliferation of these scanners at the home and these applications. Also remember that small or medium sized businesses use the ATM as well where you have bunch checks, bunch notes which is much more difficult to use at home.
It would take a much longer period of time and be a little bit more cumbersome with the at-home scanner to do this. So it is a very specific application.
It is not for small or medium sized businesses in aggregate.
John Bruno
And it is fixed. That is the real issue.
How our customers see it is as an addition to their value offering to their customers both consumer and small to medium sized business that says you obviously have to do things when you are on the move and you want to do things in your small home office. They see it as a value add.
To Bill’s point the size of the market is so large the penetration of this we don’t see cannibalization for quite some time if at all.
Bill Nuti
Frankly if there is we want to be players on both sides of the spectrum. Thanks very much for your call today everybody.
We appreciated your time and we look forward to talking to you again at the end of next quarter. All the best.