Jul 28, 2015
Executives
Gavin A. Bell - Vice President-Cross Line Business William R.
Nuti - Chairman, President & Chief Executive Officer Robert P. Fishman - SVP, Chief Financial & Accounting Officer Andrew S.
Heyman - SVP, President, NCR Financial Services Michael Bayer - Senior VP & President-Retail Solutions Division Paul Langenbahn - Senior Vice President and President-Hospitality, NCR Corp.
Analysts
Paul Coster - JPMorgan Securities LLC Ian A. Zaffino - Oppenheimer & Co., Inc.
(Broker) Gil B. Luria - Wedbush Securities, Inc.
Kathryn L. Huberty - Morgan Stanley & Co.
LLC Daniel R. Perlin - RBC Capital Markets LLC S.K.Prasad Borra - Goldman Sachs International Meghna B.
Ladha - Susquehanna Financial Group LLLP Matt Summerville - Alembic Global Advisors
Operator
Please stand by. Good day, ladies and gentlemen.
Welcome to the NCR Corporation's Second Quarter Fiscal Year 2015 Earnings Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Mr. Gavin Bell, Vice President of Investor Relations.
Please go ahead, sir.
Gavin A. Bell - Vice President-Cross Line Business
Good afternoon and thank you for joining our second quarter 2015 earnings call. Joining me on the call today and offering opening remarks are Bill Nuti, Chairman and Chief Executive Officer, and Bob Fishman, Chief Financial Officer.
Additionally, available on the call today for Q&A are Andy Heyman, Senior Vice President and President-Financial Services; Michael Bayer, Senior Vice President and President-Retail Solutions; and Paul Langenbahn, Senior Vice President and President of Hospitality. Our presentations and discussions today include forecasts and statements that are considered forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.
While these statements reflect our current outlook, expectations and beliefs, they are subject to a number of risks and uncertainties that could cause actual results to vary materially. These risks and uncertainties are described in our earnings release and in our periodic filings with the SEC, including our Annual Report to stockholders.
On today's call, we will be referring to presentation materials posted on our website. We will also be discussing certain non-GAAP financial information such as free cash flow and results excluding the impact of pension and other items.
Reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measures, and other information concerning such measures, are included in the presentation materials and in our earnings release. These are also available on the Investor Relations section of NCR's website.
A replay of the call will be available later today on our website, ncr.com. With that, I'd like to turn the call over to Bill Nuti.
William R. Nuti - Chairman, President & Chief Executive Officer
Thanks, Gavin. Good afternoon, everyone, and thank you for joining us today.
I am pleased with our second quarter results, which were in line with our expectations. We have reached the midpoint of 2015 and remain on track to achieve our full-year goals, despite the increased pressure on revenue and profitability from foreign currency headwinds from our initial 2015 guidance.
The NCR team has executed well this year, and I am particularly pleased with the progress we've made towards becoming a software-driven, hardware-enabled company. This progress is evident in our results, culture, in our management system, and the talent we've been able to attract.
Turning to slide number three, which shows our financial highlights for the quarter. Q2 revenue was down 3% compared to last year due to the impact of FX, but was up 4% on a constant currency basis.
Recurring revenue now represents 42% of total revenue and was down 3% on an as-reported basis compared to last year, but up 3% on a constant currency basis. Operational gross margin in Q2 was 29.1%, which was down 90 basis points, primarily due to an unfavorable mix of revenue.
Q2 NPOI was $202 million, which is above our guidance range of $190 million to $200 million. NPOI was down 4% on an as-reported basis, but up 4% on a constant currency basis.
Non-GAAP EPS was $0.66 in Q2, which was down 3% as reported, and up 6% on a constant currency basis. And lastly, our free cash flow execution and results continue to improve.
Free cash flow increased $92 million in Q2 compared to last year, to $95 million. For the first six months of the year, free cash flow is $119 million, compared to a free cash outflow of $48 million in the first half of 2014.
As you know, increasing free cash flow and improving annual linearity are key areas of focus, and I am pleased with our progress this year. And now on slide number four, which provides some more detail on our software-related revenue growth, which was down 1% as reported, but up 3% constant currency.
Year-to-date, software revenue was up 2% as reported, and up 6% constant currency. Within our software revenue streams, we saw continued momentum in cloud growth, up 9% constant currency, year-over-year.
Software-related revenue continues to grow faster than our other revenue streams. While it's been by design, over the medium to long term, consistent mid- to high-single-digit software-related revenue growth will continue to positively impact our top line, margins and free cash flow.
On our last call, we talked about the launch of NCR Kalpana, our cloud-based ATM software platform that transforms how financial institutions operate and makes running their business easier. Kalpana is one example of our commitment to helping our customers significantly lower their total cost of ownership through disruptive innovation.
Slide number five shows our latest disruptive innovation in the retail market. NCR Retail ONE, just announced in June to over 700 customers at our Synergy conference, is a powerful software platform designed to help retailers implement omni-channel and stay relevant in their industry.
NCR Retail ONE is an intelligent, open commerce hub and integrates retail applications and back-end data sources to deliver the next generation of productivity gains and consumer experience innovation to the retail market. Retail ONE can be implemented via a public or private cloud implementation, enterprise on-premise software license, or a hybrid of both.
We believe the open nature of the platform is particularly important, as it gives retailers tremendous choice and flexibility. NCR Retail ONE can mix and match software applications from NCR, our partners, retail applications and even third parties, which means that solutions can be easily and seamlessly deployed.
Recent research showed that 86% of the retail community plan to implement a unified commerce system in response to the connected consumer and the rapidly changing shopper experience. However, of that 86%, nearly half are saying that they are struggling to integrate legacy systems across channels.
Retail ONE enables gradual migration, which solves that problem and allows retailers to differentiate their businesses and the shopping experience they provide consumers, without expensive transitions from legacy infrastructure. In addition to the platform innovation of Retail ONE, we continue our partnership in the go-to-market, application development, and security areas with Intel, Microsoft and Cisco, as well as other key partners.
Overall, we are excited about the launch of Retail ONE and the value it offers retailers of all sizes as they continue to bridge physical and digital channels and offer flexible payment options from physical to online to mobile. Lastly, slide number six shows our key highlights for Q2.
First, Q2 was in line with our expectations and we experienced improved stability and balance across our businesses. We are at the halfway point of the year and remain on track to achieve our goals for the full year.
Our Financial Services business continues to generate solid results. Our order growth was again up in Q2, and backlog supports improved revenue growth in the second half of the year and into early 2016.
Our Branch Transformation solutions and CxP software portfolio continue to drive significant demand and we remain confident in these trends. In Retail, we continue to be encouraged by improving industry dynamics.
Those signs, including improved execution, helped us achieve higher-than-expected order growth in Q2 after a very strong Q1. Order growth was bolstered by a large self-checkout win in Europe.
This shift in customer spending priorities is gaining further traction, and we are optimistic that momentum in Retail Solutions will be maintained in the second half of 2015. We're optimistic about Retail ONE and the positive early response it has received in the market, including from industry partners.
We're also excited about our ongoing leadership in self-checkout. As the latest RBR report states, NCR shipped more SCO units in 2014 than all other vendors combined, and this was the fifth consecutive year we accomplished that goal.
We also increased our share of electronic points of sale technology, including, and for the first time ever, reaching the number one market share position in North America. Hospitality had a good quarter that included solid operating margin expansion due to higher software revenues, driven by cloud growth.
Hospitality continues to improve the foundation of their business while marching forward on their strategic plan. Software revenue growth across NCR was another key highlight for the quarter, particularly our cloud revenue growth.
We have also further advanced our efforts to build a better NCR. The transformation of our sales and services organizations is delivering results and our restructuring initiative remains on track.
We are also pleased to announce that the Securities and Exchange Commission, after a lengthy review, stated it does not plan to recommend an enforcement action related to a previously disclosed investigation concerning certain aspects of our compliance with the Foreign Corrupt Practices Act. Finally, free cash flow is tracking well ahead of last year and we are focused on continuing to drive free cash flow growth and NERP (12:12) as we move through the rest of 2015.
In summary, I am pleased with the second quarter and by the improving execution across NCR. Before turning it over to Bob for the financials, I want to take a moment and let everyone know we will be hosting an Analyst Day at the New York Stock Exchange on September 15.
It has been some time since we held an Analyst Day, and we think the time is right to meet all of you in person and continue having a dialogue about NCR and our strategic vision. I certainly hope that all of you can join us and hear from not just myself and Bob, but the rest of our executive team as well.
Now I'd like to turn the call over to Bob to review our performance by segment and our financials. Bob?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
Thank you, Bill. I'll start on slide seven, which shows our Q2 operational results on an as-reported and constant currency basis, which Bill previously discussed.
We experienced unfavorable foreign currency fluctuations during Q2, with impacts of approximately $110 million in revenue, $16 million in NPOI and $0.06 in EPS, all roughly in line with our previous expectations. Revenue was higher by 4%, NPOI was higher than 4%, and non-GAAP EPS was higher by 6%, all on a constant currency basis.
The next slide shows our Q2 GAAP results. The decrease in GAAP results is primarily related to the noncash settlement of a pension plan in the U.K., which I will cover in more detail on slide 15.
Additionally, the restructuring plan and FX also contributed to the decrease in GAAP results. The restructuring plan charge included in income from operations was $8 million in Q2 2015.
On slide nine, you will see our Financial Services Q2 results. On a constant currency basis, revenue was up 1% due to improvements in the Americas, Western Europe and Middle East/Africa, offset by declines in Russia and China.
Excluding Russia and China, revenue was up 4% on a constant currency basis. Operating margin was down 60 basis points at 14.6% and down 40 basis points on a constant currency basis.
The decline was due to a less favorable mix of revenue in North America and Europe and lower revenue in Russia and China. From a solutions perspective, our Branch Transformation revenues were up 140% during the quarter, led by North America and Middle East/Africa.
We added a number of wins for our Cx Banking and Payments software, driving Enterprise Software growth of 20% in the quarter on a constant currency basis. Additionally, our digital banking user growth continues to reach record levels due to increased sales capacity and Net Promoter Score.
Our New Services offerings are gaining traction to support customer needs for higher availability, efficient infrastructure costs and reduced risks. The next slide shows our Retail Solutions Q2 results.
Revenue was flat as reported and up 7% on a constant currency basis, due to increased spending by retailers in North America and Europe. Operating margin was 8.3% and decreased 100 basis points on a constant currency basis.
Retail operating income was lower than the prior year due to a less favorable mix of revenue in North America and was up significantly as compared to Q1 2015. Key developments for Retail include the spending shift back towards omni-channel solutions, which gained further traction in the quarter.
We are expecting improvement in Retail in the second half of 2015. We experienced positive order momentum in Q2 after strong orders in Q1, including a major new self-checkout win in Q2.
We also continued to demonstrate our global leadership in self-checkout and are pleased with becoming number one in point of sale in North America for the first time ever, according to RBR. In addition, we are excited about the recent launch of our Retail ONE omni-commerce platform.
Our Connected Payments software solution continues to drive strong cloud revenue growth and we saw sequential growth in managed services revenue, driven by the successful onboarding of one of our top customers. Turning to the next slide.
Hospitality revenue was up 4% on a constant currency basis, driven by improvements in the higher-margin revenue streams offset by lower hardware revenue. Software-related revenue was up 11%, which includes cloud revenue, up 23%.
Additionally, cloud application sites increased 18%. Operating margin performance was 15.7%, up 220 basis points due to this higher software-related revenue, including cloud and professional services revenue.
In Q2, we launched Orderman7 to the U.S. market.
We saw growth in international software-related revenue, which is up 12% year-on-year. And we continued to see progress in the North America SMB market, with 8% revenue growth and 18% software-related revenue growth.
Additionally, we continued our focus on managed services by adding menu maintenance offerings for franchisees of Quick Service brands. Next looking at our Emerging Industries business on slide 12.
Revenue was up 2% year-over-year and up 11% on a constant currency basis, driven by an increase in Telecom and Technology constant currency revenue. Operating margin was 11.5%, up 910 basis points, driven by higher services margin.
On slide 13, you can see the solid growth in cloud revenue on an as-reported basis. On a constant currency basis, cloud was up 9% and software-related revenue grew 3%.
Hardware revenue was down 2% as reported, up 6% on a constant currency basis. And Other Services, which includes our traditional break/fix business, was down by 6% as reported, up 2% on a constant currency basis.
On slide 14, you can see free cash flow for the quarter. Free cash flow for Q2 2015 was $95 million compared to $3 million in the prior quarter.
On a year-to-date basis, free cash flow was $119 million compared to a free cash outflow of $48 million in the prior year. The increases in free cash flow were mainly due to improvements in cash from operations, lower capital expenditures and lower discontinued operations.
As a result of our strong first half of the year, we are increasing our full-year free cash flow guidance range from $325 million to $375 million to $350 million to $400 million in 2015. Slide 15 is a summary of our recent UK London pension plan transaction.
This transaction is something of a milestone as it completes Phase III of our multi-year pension de-risking strategy. Our de-risking strategy focused on plans which posed the largest enterprise risk to the company and over the past few years we have been working to either shrink or terminate them.
We announced the start of this UK transaction several quarters ago and in Q2 we successfully settled the transaction by transferring the plan to an insurer. This was our largest international plan and transferring it reduces our global pension liability by about 19% and helps our cash flow by reducing our recurring international cash contributions.
We estimate that we will have saved approximately $100 million in projected plan contributions that we otherwise would have made over the period from 2014 to 2017. This transfer also benefits and reduces risk to the over 5,000 plan participants that are either current or former employees.
As a result of this settlement, we incurred a non-cash GAAP charge of $427 million or $2.51 per diluted share in the quarter and recording an offsetting decrease to prepaid pension costs in the June 30 balance sheet. Slide 16 is an update on the restructuring plan.
We incurred a pre-tax charge of $24 million in the first half of 2015 and expect to incur an additional $15 million to $40 million in 2015. The cash impact was $30 million in the first half of 2015 and we expect to pay an additional $41 million to $56 million in 2015.
As far as savings generated, we achieved $18 million in 2014 and estimate approximately $70 million in 2015 and approximately $105 million in 2016. As previously communicated, we expect approximately 50% of the savings to benefit NPOI, with the remainder reinvested in the business.
Slide 17 shows our net-debt-to-EBITDA metric, where we closed Q2 with a leverage ratio of 3.1 times. This was benefited from our strong free cash flow generation in the quarter.
Slide 18 shows our full-year 2015 guidance. We are reaffirming our full-year revenue and non-GAAP guidance.
We have updated our GAAP income from operations and GAAP diluted EPS guidance to include the impact of the UK London pension plan noncash settlement charge. We have increased our free cash flow guidance to $350 million to $400 million.
Slide 19 shows our 2015 full-year revenue guidance by segment. We are reaffirming our revenue growth by segment.
On slide 20 you will find our Q3 2015 guidance. I expect as-reported revenue will be in the range of $1.63 billion to $1.65 billion.
This includes a negative FX impact of roughly six points compared to the prior year. Revenue is expected to be up 5% to 6% on a constant currency basis.
I expect NPOI to be negatively impacted by roughly $17 million of FX. Based on the midpoint of the range, NPOI growth is expected to be up 5% on an as-reported basis and up 14% on a constant currency basis.
Now I'll open up the call for questions.
Operator
Up first, you'll hear from Paul Coster, JPMorgan.
Paul Coster - JPMorgan Securities LLC
Yeah, thanks very much. Inevitable question, but can you give us some color regarding the ongoing strategic review, and also reports in the press that you are in negotiations with private equity on an LBO?
And I have a quick follow-up.
William R. Nuti - Chairman, President & Chief Executive Officer
Sure, Paul. I will not comment on the latter, just to say that the strategic alternatives review is – remains underway and we expect that process to conclude in the near future.
Paul Coster - JPMorgan Securities LLC
Ahead of the analyst event, do you think?
William R. Nuti - Chairman, President & Chief Executive Officer
Quite possible, yes.
Paul Coster - JPMorgan Securities LLC
Okay. All right.
And then my other question really is just on orders. I didn't really sort of pick up the themes somewhat, in Retail and Financial Services.
Can you just sort of give us a little bit of color about orders? I know that it's more difficult to get visibility from – in the financial services sector these days, but what can you tell us, Bill?
William R. Nuti - Chairman, President & Chief Executive Officer
Yeah, so let me give you a little bit of color. I was quite pleased with orders in Q2, as we were in Q1.
I'll have Andy and Michael also contribute, but the high points, Paul, are that on a currency-neutral basis, Financial was up year-over-year about 6% and Retail was up about 13%. So Retail had a really strong Q2 again in orders, but it was partially – a good guy was really a big win we had in Europe in self-checkout as well, but even without that, the numbers would have been quite good.
But Andy and/or Michael, I'll go to you, Andy, first. Any color on orders for Paul?
Andrew S. Heyman - SVP, President, NCR Financial Services
Yeah, it's Andy first, with Financial Services. I would just add to what Bill said.
We had a really good quarter in orders, and when you look at the underlying fundamentals, Russia and China have been fairly significant headwinds for us, and when you normalize for those two, they were probably about a 600-basis-point impact, so call it 13% order growth, right around there, for the rest of the world, FX-neutral. So a really good quarter in terms of order and backlog growth for Financial Services.
William R. Nuti - Chairman, President & Chief Executive Officer
And, Michael, for retail?
Michael Bayer - Senior VP & President-Retail Solutions Division
Yes, as you already mentioned, we had a strong quarter in Q1 and we saw continued strength globally on the order front, and that was also already in Q1 my statement supporting the growth in the second half of the year. Due to our order versus recognition policy, we will see this additional roll-out and these additional revenues to materialize in the second half.
Even on an as-reported like-for-like basis, we have grown year-to-date high single digits, and all of that just underlines performance back to natural spending of our retail customers.
William R. Nuti - Chairman, President & Chief Executive Officer
And, Paul, the only other two comments I'd make are two important metrics we track. In Financial, Branch Transformation orders were about 100% year-over-year on a big number, so that was quite a significant growth in Branch.
And self-checkout orders were up 46% year-over-year.
Paul Coster - JPMorgan Securities LLC
Thank you very much.
William R. Nuti - Chairman, President & Chief Executive Officer
Thanks.
Operator
Next up we'll hear from Ian Zaffino, Oppenheimer.
Ian A. Zaffino - Oppenheimer & Co., Inc. (Broker)
Hi, great. Thank you very much.
Just drilling down a little bit more on the Retail business, the big self-checkout win, was that with a new customer or is that an existing customer that just re-upped? And if you could give us a little bit more color on that, that'd be helpful.
William R. Nuti - Chairman, President & Chief Executive Officer
Sure, Ian. I'll let Michael give you some more color, but the answer quickly is it was a new customer win.
But, Michael, some more color on that?
Michael Bayer - Senior VP & President-Retail Solutions Division
Yeah, It was new, and we will be able and allowed to disclose it publicly after we finish the installation, which is supposed to finish early November. And it was a replacement of the biggest customer of one of our competitors.
Ian A. Zaffino - Oppenheimer & Co., Inc. (Broker)
So you replaced another competitor's self-checkout machine with your own self-checkout machine? Or is it an assisted checkout machine replaced with your own self-checkout?
Michael Bayer - Senior VP & President-Retail Solutions Division
No, it's a complete competitive replacement and expansion of their self-checkout strategy. So we will not replace like-for-like; we will replace with different colors in terms of user – usage of the self-checkout, card-only and combined, as well as the high intensity of the self-checkout in that particular customer.
Ian A. Zaffino - Oppenheimer & Co., Inc. (Broker)
Okay. Thank you.
And then just following up, Bill, on your comment about the bank Branch Transformation new business and new wins, was that business related to new locations opening up with your new machines? Or were they pulling out old machines and replacing them with your new machines?
William R. Nuti - Chairman, President & Chief Executive Officer
Andy, why don't you comment on that?
Andrew S. Heyman - SVP, President, NCR Financial Services
Yeah, think of it less as new branches, although there is certainly a percentage, but it's a small percentage of the order growth related to new branch openings. It's more additive to an ATM fleet, or a replacement of a portion of an ATM fleet within existing branches.
So that's the vast majority of the growth that Bill was mentioning, in terms of order growth for Branch.
Ian A. Zaffino - Oppenheimer & Co., Inc. (Broker)
Okay, great. Thank you.
Good quarter. Good to see the cash flow coming in.
Thanks a lot. Take care.
William R. Nuti - Chairman, President & Chief Executive Officer
Thanks, Ian.
Operator
Next up is Gil Luria, Wedbush Securities.
Gil B. Luria - Wedbush Securities, Inc.
Yes. Thanks for taking my question.
The software business decelerated in the quarter, even the tip of the spear, the cloud, is only growing high single digits, the rest low single digits. What is it that slowed that business down?
Are there any temporary factors you think will reverse themselves going forward?
William R. Nuti - Chairman, President & Chief Executive Officer
Yeah, Gil. I'm quite enthusiastic, actually, about software growth on the year.
In fact, the current forecast for Q3 software growth is extremely healthy. I think if you look back to Q2, I would just say it's a matter of being a bit lumpy.
That business, still, I was quite pleased with the cloud growth of high single digits. I expect cloud to continue to be high to low double-digit growth for the foreseeable future, and I would expect that for the full year, we'll be in the high single-digit growth range for software-related revenue.
So we feel good about that right now.
Gil B. Luria - Wedbush Securities, Inc.
Then in terms of China, can you give us a sense of where we are compared to the peak? What year did that business peak, and what's the year going to be like in terms of China relative to that peak?
William R. Nuti - Chairman, President & Chief Executive Officer
Andy, why don't you take that one.
Andrew S. Heyman - SVP, President, NCR Financial Services
Sure. In terms of China, if you go back in time and look at, say, 2012, 2013, it was in the $170 million to $180 million range, in both of those years, and I think the peak was 2013 at the mid-$180 millions.
And so you kind of fast-forward to today and it's a business that this year is going to be closer to $100 million or so, so it's been a significant decline in China. As we look ahead, there's quite a bit of activity going on.
First of all, there's been significant government shifts in terms of what has to be purchased from local providers. That's created a large number of local competitors, and a lot of activity that's happening there that's affected so much the revenues that we're looking at right now in terms of our declines.
We do believe, both for China and Russia, that should normalize as we head into the first quarter of 2016. And then, specifically in China, we have several activities underway, that have been underway since late last year, for going local, building a local brand with partners to not only stem the declines, but also with a much more software-driven strategy, build a new normal for us in terms of growth rates.
But that's where we currently are, Gil.
Gil B. Luria - Wedbush Securities, Inc.
Got it. And then last question on pensions, I just want to go through the impact, because it sounds like you're going to add $427 million to the underfunded status.
You talked about estimated cash savings. Were those already included in your guidance?
And then the pension expense increase of 15% – of $15 million, is that the income statement, the one you back out of NPOI?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
Yeah. So the improvement in cash flow, Gil, is already included in our estimate of pension contributions for the year.
Then you had a question on the $15 million of expense. Yes, that is P&L, so that's income statement.
That is included in our pension expense guidance this year. That number's around $10 million this year for pension expense.
And one thing that's nice about this particular transaction, with it being the end of Phase III, we will be moving to a more traditional operating income metric next year. So this idea of NPOI, where investors are trying to figure out what the P stands for, think of us moving toward a more traditional operating income and also focusing more on EBITDA next year.
And then you had another question, Gil, on the underfunded, is that right?
Gil B. Luria - Wedbush Securities, Inc.
Yeah. The $427 million gets added to the $168 million that you ended the last year?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
That's exactly right. So we finished last year at the $168 million.
Add $427 million; that means at the end of Q2, we're close to $600 million underfunded. That's what we spoke about two quarters ago, that we were headed in that direction.
But think of that as being two-thirds the U.S. plan, and one-third Germany.
Gil B. Luria - Wedbush Securities, Inc.
So too early to congratulate – can we congratulate you on the completion of Phase III? Are you done with a multi-year journey of cleaning up pensions?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
I will take that congratulations, Gil. We've been working long and hard.
We started this process three to four years ago. Phase III does mark the culmination of our work on pension, so I appreciate the congratulations.
Gil B. Luria - Wedbush Securities, Inc.
Thank you very much. Thank you.
Operator
From Morgan Stanley, we'll hear from Katy Huberty.
Kathryn L. Huberty - Morgan Stanley & Co. LLC
Yes. Thanks.
First a clarification, I just want to go back and make sure I understand the timing of the big self-checkout deal that you've brought up a couple times on this call. So the majority of the revenue would hit in the calendar fourth quarter of this year?
Is that correct?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
(36:13)
Michael Bayer - Senior VP & President-Retail Solutions Division
The majority – oh, sorry.
William R. Nuti - Chairman, President & Chief Executive Officer
Go ahead, Michael.
Michael Bayer - Senior VP & President-Retail Solutions Division
Majority will hit in Q3. I've taken some of the revenue in June, but not fundamental.
It will finish it in October, early November.
Kathryn L. Huberty - Morgan Stanley & Co. LLC
Okay. And when you talked about the recovery in Retail as you went through this year, were you thinking that this deal would come through?
Or is this incremental to the recovery that you had talked about last quarter?
William R. Nuti - Chairman, President & Chief Executive Officer
Go ahead, Michael.
Michael Bayer - Senior VP & President-Retail Solutions Division
Well we of course worked at this win for quite some time. We started the detail work of such a win, it takes 9 to 12 months, so we started that in Q4.
But there was also recovery in Russia. We, quite frankly, have had good performance in Russia from an order point of view, which will also turn into revenue second half, again, on the self-checkout front.
We have one pilot with all of the five leading retailers in Russia. We see more and more interest also in Latin America.
So we continue to lead with a strong self-checkout portfolio, with the strong value proposition of our self-checkout software. As you will also see that our portfolio is expanding to have self-checkout units for card-only self-checkout in convenience stores.
And as Bill mentioned before, that in combination with quite some significant wins for POS hardware roll-outs, those orders made the good performance and will positively influence our second half.
Kathryn L. Huberty - Morgan Stanley & Co. LLC
Okay, great. And then in Financial Services, we have talked in the past about the weakness in Brazil and China, so that's not necessarily new.
There were some comments about weaker mix in North America. Was there something that surprised you in the developed markets this quarter in addition to the emerging market weakness?
William R. Nuti - Chairman, President & Chief Executive Officer
Go ahead, Andy.
Andrew S. Heyman - SVP, President, NCR Financial Services
The way, Katie, I think about that right now is larger banks in the second quarter made up a higher proportion of our revenues in the developed markets. That's the simple math on it.
And we see that normalizing as we exit the year. So that's the phenomenon in the second quarter that occurred.
Kathryn L. Huberty - Morgan Stanley & Co. LLC
Okay. All right.
And then maybe a question for Bill and Bob. If I just take a step back, you've driven this mix shift towards software-related revenue over the last couple of years.
And when we look at the gross margin line, ex-currency it dropped by 100 basis points. Can you just talk about some of the offsetting factors that are limiting gross margin expansion as you go through this mix shift in the business?
Thank you. And that's my last question.
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
Yeah, no doubt that driving more software as a piece of total revenue is important in terms of driving gross margin rate expansion. We look at the margin by product, which includes the hardware piece of our business as well as services.
The services margin is improving nicely and that reflects the recurring revenue stream and a lot of the work that we're doing in services, including higher-value managed services. And each of the divisions can speak to that as well.
Within the product piece, that moves along with hardware. And hardware margin rates can be influenced by bigger roll-outs in a particular quarter that might have lower margins.
And that can often reflect the purchasing power of a particular customer. So I would say hardware margins can move around.
Actually when I look ahead and look at what should be a record number of new product introductions over the next year or so, I'm confident that hardware margins will continue to improve. The good thing about new products is that you have an opportunity to take cost out of new products to improve the gross margin rate.
So that's really what we're seeing in terms of pressure on the Q2 margin rate. Michael or Andy, did you want to talk a little bit about some of your managed service piece of the business and how service margins are improving?
Andrew S. Heyman - SVP, President, NCR Financial Services
Yeah, I'll jump in first, Michael, and then you can follow. Just a couple things on margin.
First of all, I do think as we normalize the mix that we talked about earlier in terms of larger bank, smaller bank, financial institutions becoming a greater percentage, I think that'll impact the margins positively as we look at the outer quarters. Specific to Bob's point about managed services, it's a business at NCR that historically had not invested in new service offers for quite some time.
We came out with about eight new service offers, either brand new ones or refined ones. And that's going to make up in terms of backlog of services in the back half of the year, it'll make up about half of our growth.
So we're looking for about 300 basis points of growth just purely from the new service offerings. So if you think about cash management services as financial institutions are more concerned about rate hikes, that's a growing area of interest and wins that we're seeing on cash management and managed services.
And then also on security services, we had a huge win in the Middle East on security services where we're doing a full end-to-end security management for a financial institution there. So we're seeing a lot of interest on the new offers around managed services.
Michael Bayer - Senior VP & President-Retail Solutions Division
Yeah, let me just add to what Andy said. We have started our journey to offer and drive more managed services offerings in Retail roughly 12 months ago.
We had since then some substantial wins. And we have just finalized or are still in the final steps of finalizing the on-boarding of one of our biggest customers in the managed service arena.
We see more and more demand and we are not even responding to that demand, we are proactively driving that demand where we look into what some of our customers call front of the house or we would call it in-store managed services, where we incorporate all technology of any third party from view of (43:14) NCR in the shop and we would service all of that and we would maintain all of that. And in some of the cases, that expands to help desk capabilities, that expands to back of the house and distribution centers.
And the customers are more and more interested to leverage our services performance and services power, which we can give them in 180 countries around the world being a major differentiator in the marketplace. So there is continuous growth for Retail.
There is continuous broadening the scope and we are investing in that area together with our services organization.
Kathryn L. Huberty - Morgan Stanley & Co. LLC
Thank you for all the detail.
William R. Nuti - Chairman, President & Chief Executive Officer
Hey, Katy. I'll give you just a few more comments on margin.
To your point, the mix shift we've been able to drive has really given us a lift over the last several years. I expect margins in the back half to be up, call it, 20 bps to 25 bps year-over-year with a strong Q3.
And I do expect us to continue to be able to drive meaningful margin expansion similar to prior years in 2016 and beyond. The one factor this year as well that has impacted us has been FX.
So on a standalone basis, going into 2016 if some of the FX were to moderate, it could be quite a good year on the margin front for us.
Kathryn L. Huberty - Morgan Stanley & Co. LLC
Thank you.
Operator
Next up is Dan Perlin, RBC Capital Markets.
Daniel R. Perlin - RBC Capital Markets LLC
Thanks. I just wanted to go back to this large managed service client in Retail.
Have you recognized any meaningful revenue in the current quarter? Or is that still going to come in the back half?
William R. Nuti - Chairman, President & Chief Executive Officer
So a couple of comments on this particular customer. This is a very large win for us that we had in Q1.
And there's no doubt that we're going to see a lift on a year-over-year basis in Q3, Q4 and Q1 of next year on this client. Michael, any other thoughts on that besides those comments?
Michael Bayer - Senior VP & President-Retail Solutions Division
No. I think you handled it perfectly, Bill.
I would just leave it that way for the time being.
Daniel R. Perlin - RBC Capital Markets LLC
Okay. So it sounds like it's still going to come.
Andy, I had a question for you about the North American mix, the shift towards large financial institutions rather than small. I can understand that it bounces around a little bit, I just, my question is what does that tell us – or is there something indicative about the cross-selling opportunities that we saw in the current quarter around kind of DI, which is clearly, tilts towards more mid- and small financial institutions, and I think was a big part of the incremental growth driving part of the story long-term?
Andrew S. Heyman - SVP, President, NCR Financial Services
Yes, it's a good question. First of all, NAMER, North America, for us was up north of 10% on a really tough compare.
They had a big second quarter last year, another big second quarter this year, so it's a really strong business for us right now. Backlog is also growing significantly.
And in terms of the mix between the larger versus the smaller financial institutions, again, a lot of that is related to what was going on a year ago, and as we look right now into the back half, we see based on the funnel, a really good shift back towards what we call our norms, where the smaller bank and bigger bank, there's more balance between the mix there. Specific to Digital Insight and how we've integrated the product offerings and the sales force, we continue on that journey.
The cross-sell last year blew away the business case. This year again it's blowing away the business case on a similar percentage.
Think of it as 40% to 50% ahead on the cross-sell. So the message to the customers continues to resonate, it's a growing stream, and so we remain really confident in a business that's got a lot of momentum.
Daniel R. Perlin - RBC Capital Markets LLC
What can you tell us about the incremental profitability to the machines you're selling today? I think in the past you've indicated that the software-embedded components of the machines you're selling are, I think you said 40% more today than they were a year or two ago.
Does that still hold? Has it gotten better, has it gotten worse?
Has it changed internationally versus domestic?
Andrew S. Heyman - SVP, President, NCR Financial Services
Right. Yeah, so probably what you're referring to would be the solutions that are sold within Branch Transformation portfolio, which last year, for us, products and services was about $130 million.
This year, what we've said is we'll add about another $100 million or so to that, so we're right on plan for that for this year. And we see a really strong quarter – I'm sorry – a really strong year for Branch Transformation.
The margins within that, yeah, you're looking at margins that would be quite a bit higher than our traditional margins. Think of it as, call it another 20% higher.
So if we're in the 20% to 30% on any given deal in traditional products, we'd be into the 40% to 50% range on Branch Transformation portfolio. So you're exactly right with your 40% comment, if not on the low end there.
The last thing I'd say on margins, just in general, is you're talking about on the machine side, but on the enterprise software side, which is the biggest part driving our growth, the enterprise software, in other words software that's sold not attached to any machine sale, that business is up north of 20% for us right now. The licenses in the quarter for that up over 30%, so we're having a huge year on the enterprise software side, and we don't see an end to that kind of growth as we look ahead.
Daniel R. Perlin - RBC Capital Markets LLC
That's great.
Andrew S. Heyman - SVP, President, NCR Financial Services
And that'll have a big impact obviously on margins, as it continues to grow faster than the rest of the revenue streams.
Daniel R. Perlin - RBC Capital Markets LLC
Okay. I just had two housekeeping questions for Bob.
One is, I'm just trying to understand the driver behind the fourth quarter spike or jump up in your Other Expense and Income. Even at the low end of the range that would imply a pretty significant ramp for that number to get you to $215 million on the low end.
And then the last is you're still sticking to like it looks like 175 million shares for 2015. Is that an indication that you're hiring some people in the back half of the year?
And if you are, what kind and where would they go?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
Yeah. On the Other Income and Expense, we were certainly encouraged by the number in Q2.
It was roughly $46 million, compared to our guidance of $55 million. In Q3, we guided again to $55 million, but you know, the lesson we learned last year is not to be too aggressive with the FX rates.
So I would say we've got some room for improvement there. We certainly look like we're headed towards the lower end of the OIE range for the full year, but we're just trying to be a bit cautious there because volatility in FX can move that number.
Hopefully you're right and there is some upside there. I would not read too much into the 175 million of shares.
I would say that could end up a little bit lower, but it really doesn't reflect increased hiring.
Daniel R. Perlin - RBC Capital Markets LLC
Okay. Thank you, guys.
Operator
Our next question comes from S.K. Prasad Borra at Goldman Sachs.
S.K.Prasad Borra - Goldman Sachs International
Thanks for taking my questions. Probably to start off, can you elaborate on what are the strategic alternatives, or what are the options you have at your disposal?
William R. Nuti - Chairman, President & Chief Executive Officer
You know, on prior calls I've talked about the full range of strategic alternatives that we as a board routinely look at, everything from returning capital to shareholders in the forms of dividends or buybacks, to divestitures of businesses that are non-core, to spin-off alternatives of businesses that are also non-core, to a full sale of the company, to a host of other items. So I would say that as a board, annually, we do a really good job of looking at everything, and all of those things therein.
And we've been particularly diligent this year around all of them, and as I said earlier, we should be concluding that process shortly.
S.K.Prasad Borra - Goldman Sachs International
Okay. Probably just one question on pensions.
Can you please update on what the state is of the net pension obligations? Is Phase III the last big phase of addressing the pension issue, or is there anything else after that?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
No, that's really it. The Phase III marks the end of our pension journey.
So basically, the guidance that we've given in terms of the pension contributions of $30 million to $35 million for this year includes all of the work that we've done.
S.K.Prasad Borra - Goldman Sachs International
And probably just the last one. From a competition point of view, as you're expanding your services portfolio across both Financial Services and Retail, has your competitive landscape changed much?
And is it pretty intense? Do you have to compromise on the margins, or do you think actually it's a better margin profile and you can net-to-net expand margins?
William R. Nuti - Chairman, President & Chief Executive Officer
A couple of things I'd comment on, and then maybe Andy and Michael have some additional views. But at the enterprise level, one of the accomplishments amongst several in the last year that we've had is, we can now see in our funnel, as a result of investments we've been making for a long period of time, a fairly strong growth of our services business going into 2016.
Now the mix of that is also changing. We have built and developed and now launched a set of new offers in the market that are more managed-services based, and they are lower cost to deliver kinds of services that leverage our fixed-cost infrastructure.
So one of the things I'm quite enthusiastic about going forward right now is our services growth going into 2016, the mix shift that will begin to occur as a result of higher margin offers, and some of the successes we've had early on in our journey there. Andy or Michael, any further comments there?
Andrew S. Heyman - SVP, President, NCR Financial Services
Yeah, it's Andy. Let me just jump in real quick and then hand it to Michael.
If you think about – first of all, we are not interested in just any managed service. What we're interested in is managed services that leverage our assets, whether it be our infrastructure assets or our software assets.
And just to pick one example which is around cash management, we can deliver cash management as a license, we can deliver cash management software as a SaaS subscription offering, or we can deliver it as a managed service offering. And so in a managed service offering, a customer is looking to build business processes to help them reduce their dependency on cash, optimize their cash in their network, and reduce logistics costs associated with cash deployment.
Our software does that really well. And then for banks or other financial institutions not able to put the right business process around that, then we can add an additional service around that, so when we're leveraging these assets, the margins go from anywhere from the 20% to 30% for traditional maintenance break/fix services, we can add 10 to 15 to 20 points onto that when we're leveraging our software assets.
That's where we're seeing a lot of new offer and the growth on managed services.
Michael Bayer - Senior VP & President-Retail Solutions Division
I think I talked already around our managed services growth, but as Andy was mentioning, the cash management, that was also a new offering we brought to a much broader audience in our self-checkout units, as we've incorporated cash management software on a broader scheme and with a much more analytics around it throughout the last 12 months, to help our customers to reduce the cash in all of the self-checkout units they have, and combine it with a cash management for the store. We also have expanded our offerings into protective services and in the whole security and security analytics for our customers.
So driven all of that by a strong service coverage, as I mentioned before, is giving us the possibility to extend service offerings for existing customers, or to both for new customers, which might not necessarily have a big footprint of NCR, but given our services offerings and the broadness of our third-party portfolio which we can handle, we are a very competitive and interesting partner.
William R. Nuti - Chairman, President & Chief Executive Officer
Yeah. I would like to bring in maybe Paul Langenbahn into this discussion, who runs Hospitality for us.
First of all, Paul has done a great job in his role and has really brought a level of stability back to Hospitality, a level of high performance to that team. Both Bob and I couldn't be more pleased with his software-related revenue growth, his cloud growth, and how well that business is now positioned for growth and margin expansion long-term.
But Paul is also working on a plan around services expansion. Paul, maybe you could make a few comments there?
Paul Langenbahn - Senior Vice President and President-Hospitality, NCR Corp.
Sure, Bill. I think it's largely the same story.
It's where the intersection of the assets and the capabilities the company has with a market need and ways we can add value in the market. One example that's sort of an analogue to the cash management model in Financial Services is around menu maintenance.
So we have software that controls all of the menu maintenance, which is the items and the recipes and the prices and so on and so forth across a network of point-of-sale systems. And when you look at, for example, large, heavily-franchised quick-serve restaurant brands, the franchisor in most cases cannot or will not set the pricing for the franchisees.
And the franchisees often don't have a lot of infrastructure, they don't have big IT staffs, they don't have a lot of administrative support often in their businesses. And there's tens of thousands of sites that are already customers of NCRs in this space.
So one of the things we've been able to do is using our cloud-based menu management software is actually package up a managed service around that where we're able to very efficiently do that work for thousands of quick-serve restaurant franchise locations. So that's one example.
There's other examples where we're leveraging capabilities. For example, a companion product to one of our SaaS offerings is actually deploying a managed firewall as a managed service to secure a small business or a franchise location's network inside their store to make their network more secure.
And we have thousands of sites now that have signed up for that service as well. So there's a few examples where we're really leveraging the assets of the company to add value for our customers.
And those things tend to be not only very good for our customers, but very high-margin services for NCR.
S.K.Prasad Borra - Goldman Sachs International
Thank you.
Operator
Our next question comes from Meghna Ladha, Susquehanna.
Meghna B. Ladha - Susquehanna Financial Group LLLP
Hi. Good evening.
Thanks for taking my questions. Most of them have been answered.
But can you talk about the competitive environment as it relates to the Financial Services business? Which markets are you specifically gaining share and why?
William R. Nuti - Chairman, President & Chief Executive Officer
Andy?
Andrew S. Heyman - SVP, President, NCR Financial Services
Yeah, as we look at share, we're watching obviously closely the competitive reports from who is publicly traded and then we have good checks in the field for others. It looks like right now we're gaining share in most markets.
The exception would be when there's competition where we're seeing some irrational pricing in certain markets that we feel like is one-time in nature. We've seen it a little bit in parts of Europe, we've seen it in parts of Asia, we've already mentioned what's going on in China.
So those would be the ones I would call out.
Meghna B. Ladha - Susquehanna Financial Group LLLP
Thank you.
Operator
Next up is Matt Summerville, Alembic Global Advisors.
Matt Summerville - Alembic Global Advisors
Hey, guys. I want to spend a minute talking about free cash flow.
Can you guys remind me how you're being incented going forward on free cash versus how you were incented in the past? And specifically, Bob, maybe what you're doing to improve linearity and how we should think about the sustainability of linearity.
William R. Nuti - Chairman, President & Chief Executive Officer
Hey, Matt. Welcome back.
And so we are now about 40% of the bonus of all of the management team at NCR is currently linked to free cash flow targets. We had that bonus scheme in place as well last year for the first time, and this year.
And Bob won't toot his own horn, so I will for him. He's been doing a lot of communications and training, hand-to-hand combat, if you will, with every employee around the importance of free cash flow, what role they're playing.
Bob rolls out a video every quarter to every employee in terms of training with regard to free cash flow, the impact it can have. And I also want to compliment my team.
Certainly when you are compensated on free cash flow, it draws more attention to it perhaps. But all of them have engaged in working with us to drive a better free cash flow story, not just in aggregate, but also linearity by quarter.
Bob?
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
Yeah, maybe I'll just say a few things. Luckily I don't star in the video every month.
The employees would get tired of seeing me. But I will pick up on your linearity point, Matt.
We felt confident in increasing the free cash flow guidance for the year really because we're trying to optimize every line within the free cash flow equation. So in terms of some of the legacy issues, if you look back, in Q2 of last year we were paying for 100% of the cleanup of the Fox River.
In Q3 of last year, we ended up getting a contribution from the partner who's also in the River. So now we're under a situation where we're getting paid on a timely basis on Fox River.
We've spoken about pension contributions, those are down significantly year-on-year. We talked about driving more software, and that higher gross margin really helps my free cash flow.
The CapEx is down significantly. So we have a program in place where we look at the capital, we attach business cases to it, the capital needs to earn a hurdle rate over our weighted average cost of capital.
And so we've been effective in terms of driving CapEx improvement. Cash tax rate, we're all over that in terms of driving a low cash tax rate.
And then really a focus on working capital, optimizing inventory turns as an example. But linearity is key.
And so when we talk about these videos on a monthly basis, it's not the finance team, it's really the business team, so operations trying to drive linearity across the business. And when we talk about linearity, it's not necessarily from Q4 to Q1.
We're talking about months in the quarter. So we're trying to drive more orders and more revenue earlier in the quarter so my team has a opportunity to collect that cash.
So a lot of work around linearity. There's more room for improvement in that space, but it does help working capital to have all of the employees focused on that.
Matt Summerville - Alembic Global Advisors
And then just as my follow up, you talked a bit about how we should think about margins in Retail and the ATM business. Can you also just maybe comment, second half of the year, how we should be thinking about Emerging Industries?
I know it's a small piece of your business. And then Hospitality as well, relative to where you were at in the first half.
Robert P. Fishman - SVP, Chief Financial & Accounting Officer
Yeah, we've been very pleased with Emerging Industries. Again, two-thirds of that business is very much of a services business within the Telecom and Technology space.
And, again, at this time last year we were on-boarding a number of challenging customers. And we've worked our way through that.
Think of Emerging Industries as having hit kind of a low-double digit operating margin, that there's no reason why they can't kind of continue at that clip in Q3 and Q4. When I think about Hospitality, Paul is close to a 16% operating margin, and he should continue to improve in the back half as he drives more cloud and more software-related revenue.
Matt Summerville - Alembic Global Advisors
Great. Thanks a lot, guys.
Operator
At this time, there are no further questions. I'll hand things back to Mr.
Nuti for any additional or closing remarks.
William R. Nuti - Chairman, President & Chief Executive Officer
Well thank you all for joining us today, and we look forward to seeing you at the upcoming Analyst Day in September. Goodnight.
Operator
Ladies and gentlemen, that does conclude today's conference. We would like to thank you all for your participation.