Oct 19, 2017
Executives
Michael Nelson - Vice President, Investor Relations Mark Benjamin - President and Chief Operating Officer Bob Fishman - Executive Vice President, Chief Financial Officer and Chief Accounting Officer Paul Langenbahn - Executive Vice President, Global Software Bill Nuti - Chairman and Chief Executive Officer
Analysts
Paul Coster - JPMorgan Katy Huberty - Morgan Stanley Kartik Mehta - Northcoast Research Dan Kurnos - Benchmark Company Matt Summerville - Alembic Global Advisors
Operator
Good day, and welcome to the NCR Corporation Third Quarter Fiscal Year 2017 Earnings Conference. Today’s conference is being recorded.
At this time, I would like to turn the conference over to Mr. Michael Nelson, Vice President of Investor Relations.
Please go ahead, sir.
Michael Nelson
Good afternoon, and thank you for joining our third quarter 2017 earnings call. Joining me on the call today as our host is, Bill Nuti, Chairman and CEO; along with Mark Benjamin, President and COO; Bob Fishman, CFO and Paul Langenbahn, EVP Software.
After prepared remarks, Bill, Mark, Bob and Paul will take your questions. Before we get started, let me remind you that our presentation and discussions will include forward-looking statements.
These statements reflect our current expectations and beliefs, but they are subject to risks and uncertainties that could cause actual results to differ materially from those expectations. These risks and uncertainties are described in our earnings release and in our periodic filings with the SEC, including our Annual Report.
On today’s call, we will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts in the presentation materials and on the Investor Relations page of our website.
A replay of this call will be available later today on our website, ncr.com. With that, I would now like to turn the call over to Mark.
Mark Benjamin
Thank you, Michael, and thanks to everyone for joining us today for our third quarter conference call. I’ll begin by highlighting key developments and performance metrics for our business during the quarter.
Bob will then walk you through the financials in further detail, as well as discuss our updated outlook. Then Bill, Paul, Bob and I will take your questions.
Our Q3 results were mixed with EPS at the high-end of our guidance range and revenue at the low-end of the range. The softness in revenue was largely driven by our ATM business, where we saw weakness in some of our market, in addition to some specific large customer delays in spending, which I referenced last quarter.
Unfortunately, these specific accounts have not accelerated to the levels we had anticipated making our back-half more challenging than expected. The ATM market continues to be impacted by large customer delays and spending in North America, weakness in India, the Middle East and Africa and a more gradual conversion to the Windows 10 rollout.
These challenges have led to lower order volumes, and as a result, we are reducing our full-year financial targets, given the fourth quarter will be lower than we expected. I continue to be encouraged about NCR’s position among its well-diversified portfolio of industries we serve, as well as the mix shift we are executing upon to become a solution company, leveraging our strength in software and services.
This strategy began well before my arrival and was a key attraction for me joining the storied company, and I continue to drive our strategy forward with our long-term ambitions being key. Two important data points to remember that show the success NCR has is: one, increasing our recurring revenue stream, which now accounts for 44% of our total revenues; and two, we have close to $2 billion annual revenue software business across our industry verticals, accompanied by strong solution and industry diversification.
While we are disappointed in our reduced outlook, we did have a number of bright spots this quarter, including earnings per share that came in at the high-end of our guidance range due to disciplined cost control. We also continued to generate diversified revenue streams, including cloud revenue growth of 5% and net ACV up 37%.
We also drove significant margin expansion in Services as our Services transformation also known internally as M1 are capturing efficiencies and driving profitable growth. We remain confident that our overall strategy, market approach and diversified solutions portfolio are aligned with the long-term trends in each of our markets.
While we are experiencing some near-term challenges related to the ATM market in certain geographies, we are optimistic we have the right strategy and our solution offerings are aligned with major market trends and customer demands. I long with my leadership team, as well as our team around the globe are keenly focused on improving execution, increasing recurring revenues and continuing to build scale as we navigate near-term headwinds and rollout delays, primarily in the ATM market.
Our key goal is to build momentum and accelerate growth in 2018. Slide 4 shows a snapshot of our financial performance.
Revenue was down 1% in the third quarter and finished at the low-end of our guidance range. Revenue performance was driven by growth in our Software and Services business, offset by lower hardware revenue.
While this is not where we expected to be, we continue to show the value of a diversified business portfolio serving multiple industry segments. As I mentioned, we saw an acceleration of recurring revenue growth, which increased 4% and comprised 44% of our total revenue in the quarter.
Recurring revenue remains a key priority, particularly as we continue to expand our cloud-based solution offerings and strive to accelerate the growth of our cloud business. Our non-GAAP gross margin rate contracted 10 basis points to 29.2%.
This was primarily due to lower software license revenue and decreased hardware margins, offset by continued focus on productivity improvements in our Services segment However, our non-GAAP operating margin rate expanded 40 basis points to 14.1% due to continued focus on expense management, including lower employee-related expenses. Capturing margin expansion and profitable growth remains significant priorities as we continue to expand our higher margin software revenues.
Within Hardware, we are taking a disciplined approach, balancing market share gains with profitability. We continue to execute on our strategy to accelerate our Software growth faster than overall revenue growth, which drives further margin expansion.
Non-GAAP EPS was $0.93 and came in at the high-end of our guidance range and on a constant currency basis was up 7% year-over-year. Free cash flow was $45 million due to higher working capital in the third quarter, which we expect to improve in the fourth quarter.
Moving to Slide 5, which outlines the solution-focused strategy. We’re executing against these critical areas transforming global business and consumer interactions, omni-channel software, channel transformation and digital enablement.
Our solutions portfolio is software-driven as the future of our Financial Services, Retail and Hospitality markets will increasingly rely on decision-support platforms that can capture and provide actionable customer insights. The near and long-term focus and investment priorities of our customers across all of our markets remain strongly aligned with our offerings and strategy.
Businesses are increasingly turning to our solutions and capabilities as NCR delivers proven value to our customers and we are becoming an increasingly critical partner in the supply chain. This is evident in the petroleum and convenience retail markets, where we remain enthusiastic for NCR OPTIC, our outdoor payment terminal and interactive customer interface.
OPTIC is seeing solid adoption trends due to its smart edge capabilities, ease of use and ability to deliver a consistent consumer experience across all pumps. This solution, along with our open omni-channel software platform allows companies to bring to market growth revenue drivers and enhance the shopper experience at the pump through media content management, food offerings and seamless loyalty program integration.
We had several key wins in this space during the quarter, including Speedway, the nation’s second largest company-owned and operated convenience store chain with approximately 2,730 stores located in 21 states. OPTIC is a great example of how NCR is bringing to market innovative new technologies and expanding our addressable market.
We are excited about this new line of business and the early success we are having with large customers are encouraging signs of widespread customer adoption. We had a strong quarter for our point-of-sale solutions, including one in the petroleum and convenience market with QuikTrip, a 550-plus store chain across Wisconsin and Minnesota.
Additionally, we strengthened our long-term relationship with Bashas’, a 115 site grocery retailer based in Arizona with a point-of-sale hardware win, which complements our existing Software and Service Solutions already in place. Our expanded relationship with Bashas’ speaks to the power and benefits of our full solution suite and the impact it can have on our customers’ business capabilities.
We also continue to see a very favorable response to the global launch of our 80 Series, which we see as a competitive differentiator. BankDhofar in Oman went through a full replacement of a competitor’s machine to NCR’s 80 Series ATM.
The bank implemented integrated contactless payment for all of their new machines, as well as deployed Interactive Teller services and NCR Software and Services solutions. With that, I’ll turn it over to Bob, who will walk through our financial performance and outlook in more detail.
Bob?
Bob Fishman
Thank you, Mark. Slide 6 shows a summary of our segment results for the third quarter with increases in Software revenue of 2% and Services revenue of 3% and a decrease in Hardware revenue of 7% constant currency.
Gross margin in our Services segment expanded 460 basis points, mostly offsetting the impact of a decline of 540 basis points in our Hardware segment and 70 basis points in our Software segment. We will get into the details as we go through each segment.
Slide 7 shows our Software results. Software revenue increased 2% year-over-year, driven by cloud revenue growth, which increased 5% year-over-year.
Sequential cloud revenue growth accelerated, demonstrating the strength in our cloud business. We’re also pleased with the continued momentum of new cloud bookings in the quarter, as reflected by net ACV of $16 million, up 37% from the prior year.
Software license experienced an 11% decline as a result of a large unattached license sale in the prior year, combined with lower software license revenues attached to Hardware. However, unattached software license remains an area of strength, up 17% year-to-date and is expected to be up significantly for the full-year 2017.
Professional Services revenue increased 6% on a constant currency basis due to strength in channel transformation and digital enablement solutions. Software maintenance also showed continued growth of 3% and accelerated sequential growth.
Software gross margin rate was down due to lower software license revenue. The decrease in software license revenue was largely offset by our continued execution on strategic priorities to improve efficiency and scale in our software maintenance and cloud businesses.
We expect margin for the Software segment to increase over time as we see improved performance in software license revenues and we continue to expand software maintenance and cloud margins. Turning to Slide 8, Services had a strong quarter with 3% revenue growth and gross margin rate expansion of 460 basis points.
The revenue increase was driven by expansion in our annuity services with continued hardware maintenance growth, reflecting channel transformation trends and demand for managed and implementation services. We are pleased with the higher file value, which is the backlog metric for our Services business.
Consistent with prior periods, Services gross margin rate expanded as a result of business process improvement initiatives and a mix shift towards higher-value managed services. Our investment in big data analytics, predictive monitoring and customer onboarding continue to reduce the number of repair dispatches and allow customer service cases to be resolved more efficiently, increasing margins in the Services segment.
Incremental Services margin expansion remains a key focus as we execute our strategy. Turning to Slide 9, Hardware revenue was down 7%, excluding FX, due to lower ATM revenues and the timing of self-checkout rollouts.
Our point-of-sale hardware portfolio continues to show strength, growing 18%, reflecting market share gains and the introduction of a new 4-core omni-channel solution in the petroleum and convenience market. ATM revenue was down 17% in the third quarter, after being up 11% in Q3 of the prior year.
This was a little softer than we expected as the ATM market continues to be impacted by large customer delays in spending in North America, weakness in the Middle East and Africa and the upcoming Windows 10 conversion. As a reminder, North America has been impacted by lower than typical revenue relating to several large banks.
Self-checkout revenue was down in the period. However, we expect it to regain momentum and grow sequentially in Q4, driven by large customer rollouts amid global demand.
As a reminder, self-checkout revenue was up 86% in Q3 of last year. Hardware gross margin rate declined due to lower ATM and self-checkout volume and new product introductions.
On Slide 10, you can see free cash flow for the quarter. Free cash flow was $45 million, down from $153 million in the prior year.
The decrease was due to higher working capital in the third quarter of 2017, which we expect to improve in the fourth quarter. Our revised 2017 free cash flow guidance is $440 million to $470 million, or approximately 90% to 95% of non-GAAP net income.
The lower free cash flow is due to the decrease in our revenue guidance, which we’ll cover on a later slide. Slide 11 shows our net debt-to-EBITDA metric with a net debt leverage ratio of 2.5 times for Q3 2017, which represents continued improvement throughout 2047, and when compared to the 2.8 times at Q3 2016.
NCR remains committed to a balanced capital allocation strategy. We anticipate strong free cash flow for the remainder of the year, which should enable us to reduce our leverage multiple as we close the year.
On Slide 12, you will find our full-year 2017 guidance, which has been revised based on our expectations for the fourth quarter. We are lowering our full-year 2017 revenue, earnings per share and free cash flow guidance.
We now expect revenue of $6.475 billion to $6.525 billion, due primarily to lower expected revenue in ATMs and software license attached to Hardware. We now expect GAAP diluted earnings per share to be $1.97 to $2.09, and non-GAAP diluted earnings per share to be $3.10 to $3.20.
The reduced EPS guidance is a result of the operating income flow-through on the lower Hardware and Software revenue, partially offset by improved other income and expense and favorable share count. Slide 13 shows our revised revenue guidance by segment for the full-year.
Software is now expected to grow 2% to 3% on a constant currency basis. The revised software guidance is primarily the result of lower software license revenue attached to hardware.
Cloud is expected to grow approximately 6%, which represents accelerated sequential growth of approximately $5 million in the fourth quarter. Services is expected to grow 3% in line with previous expectations.
Hardware is now expected to be down 2% to 3%, due to lower ATM revenue. We had previously expected ATM revenue to ramp in Q4, but now expect relatively flat revenue compared to Q3 due to the reasons previously mentioned.
Total revenue is expected to be up 1% on an adjusted constant currency basis. Slide 14 includes our Q4 2017 guidance.
We expect revenue to be down 3% to 6% on a constant currency basis. I will outline Q4 revenue guidance in more detail on the following chart.
Our non-GAAP EPS is expected to be $0.83 to $0.93, down from the prior year, due to lower overall revenue, including attached software licenses. Our guidance also includes an FX benefit of $40 million in revenue and $0.08 in diluted earnings per share.
The tax rate in Q4 is expected to be 27% compared to 17% in the same period last year due to discrete tax benefits in the prior year. The full-year tax rate guidance remains unchanged at 25%.
Additionally, for Q4, we have assumed OIE of approximately $56 million and a share count of 155 million. Slide 15 shows our revenue guidance by segment for Q4.
Software is expected to be down 4% to flat compared to an increase of 10% in the same period the prior year, primarily the result of lower software license attached to hardware. Service is expected to be relatively flat due to the timing of implementation services.
Hardware is expected to be down 8% to 13%, driven by a decline in ATM revenue of approximately 30%, partially offset by growth in point-of-sale and self-checkout. The Hardware segment is facing difficult comparisons with revenue up 30% in Q4 of last year, including ATM growth of 29%.
Total revenue is expected to be down 3% to 6% on a constant currency basis. Slide 16 shows our segment results year-to-date and is a snapshot of our progress towards transforming into a Software and Services-led business.
Software revenue was up 4%, Services revenue was up 4% and Hardware revenue was up 1%. Within Software, cloud growth is up 7% and trending towards double-digit revenue growth with net ACV growth of 26%.
Our focus on selling software independent of a hardware sale is paying dividends, with unattached software license up 17% year-to-date. Recurring revenue for the year is 45% of total revenue, up 100 basis points year-over-year.
The growth in Software revenue continues to drive an increase in operating income as the Software segment is our highest gross margin business at roughly 50% and represents the largest component of our operating income at 66% of our total operating income year-to-date. Services margins have expanded 330 basis points year-to-date and reflects the execution of our business process improvement initiatives.
With that, I’ll turn it over to Mark for closing comments.
Mark Benjamin
Thanks, Bob. In closing, we realized this is a sobering quarter and I’m not taking it lightly.
However, I want you to know my thoughts on NCR as this week I celebrate my one-year anniversary. You can count on me and this team to be laser-focused on execution.
I believe we have the right vision and strategy and we’re at the very important phase in our journey with execution being critical. I’m often asked now that I’m one-year in, how I’m feeling about the opportunity.
I can confidently tell you as I’ve told our 33,000-plus NCR associates, I’m more excited about our strategy and vision today than I was when I joined the company one-year ago, and I see an incredible, exciting future. NCR is a different company today than it was just three years ago, and our current course and strategic path will continue to shape, in fact, to reshape NCR into the future.
We have powerful lying assets, which we view as our competitive advantage, necessary to be successful, including $600 million a year cloud business that continues to grow and recurring revenue that comprises 45% of total revenue. We will remain focused on executing our strategy that limits our P&L dependency on ATMs, while maintaining our market-leading solutions and excellent win rates in that market.
While we are disappointed in the need to revise our outlook, our solutions offerings and software-driven strategy remain closely aligned with the disruptive factors that continue to transform how businesses operate and interact with consumers. Moving forward, we are placing significant emphasis on driving improved execution across our entire organization by also continuing to implement business improvement initiatives that will unlock incremental margin growth opportunities.
A good example of this and something we referenced earlier, is our Services transformation which is driving solid revenue growth and impressive margin improvements that we believe will continue to take hold. We have similar programs launched or in the process of being launched and we are committed to taking a new and fresh look at every aspect of our business.
The strategy remains. The long-term growth drivers of our business remain omni-channel software, channel transformation and digital enablement.
We also continue to successfully execute critical components of our strategy as evidenced by ongoing cloud and net ACV growth, as well as further services margin expansion. Despite some near-term challenges, we remain enthusiastic about NCR’s future, our long-term growth potential and our expertise and offerings addressing the mega trends impacting our markets.
We enter the fourth quarter with a focus on our sales funnel, orders and execution as we look to drive momentum and accelerate growth in 2018. That concludes our prepared remarks.
Joining Bob and me for Q&A are Bill Nuti and Paul Langenbahn, Head of our Software business.
Operator
[Operator Instructions] We will take our first question from Paul Coster with JPMorgan. Please go ahead.
Paul Coster
Yes, thanks for taking my question. I think, the last quarter yielded you an opportunity to derisk the year.
But you stuck with this very significant year-end ramp and people were skeptical about it, you won. And I think you paid a price here.
And I’m not even sure, I understand what went wrong on the Hardware side. Are you saying that you had tough year-on-year comps?
So that was known way in advance right, or are you saying that something has happened to delay projects with large customers? And if it’s the latter, how much visibility do you have in the first-half of 2018 regarding those projects?
Thank you.
Mark Benjamin
Thanks for the question, Paul. This is Mark.
Let me start out by saying, there’s truly no one more disappointed than me here today to report these results and change our full-year guidance. And within the year, we’ve been talking about a back-half story, which was exactly what we had performed within 2016.
And we remain certainly confident in that materializing in the third and fourth quarter. What we saw here in the third quarter was really a number of different things that led us to an order decrease to what we had anticipated in the back-half that obviously flows through to revenues.
One of the factors being some of our large North American-based customers really putting off their spending relative to ATMs in the back-half of the year, which we had anticipated materializing. Now these customers are long-term, NCR customers, they remain our customers, they remain committed to the programs.
We’ve been in place with them for many years. It’s just a question right now when they’ll ramp back up their spending, which we believe is just a question of when not a question of if.
We saw some pressure in the quarter, Paul, in the Middle East, certainly around Africa and some other markets, where we saw some softness in the market that we really hadn’t encountered, as well as we were very – I think responsible as far as chasing growth opportunities that was profitable versus where we couldn’t attach our software in our services solutions. We were also more optimistic perhaps than we should have been on the Windows 10 conversion cycle, which is beginning to ramp up.
However, we’re seeing a very slow gradual pace to the financial institutions really making that part of their 2017 operation. So we also will see the benefit of that, that will ultimately become a tailwind for us sometime in 2018.
So we’re certainly disappointed in the result. We felt that we had the opportunities for the full-year.
However, we just saw some weakness in our orders. We also mentioned in previous quarters, a slowdown of our backlog conversion that we thought would also accelerate a bit better in the back-half of the year, and we’re still seeing some sluggishness, if you will, impacting fourth quarter revenues.
So Bob?
Bob Fishman
Yes. No, I agree.
If I could attach some numbers to what Mark just said. From an orders perspective, orders were down roughly $100 million in the third quarter from what we expected.
And then when we rolled up the Q4 forecast, our orders were down another $230 million. So that’s $330 million for the full-year.
When I translate that to revenue, I think of that $330 million impacting roughly $150 million of revenue. And then in terms of the lower backlog conversion rates that Mark spoke to, I think of that as another $50 million.
I’m sorry guidance has come down from a midpoint around $190 to $200 million. Think of it really as being $150 million from the lower orders and $50 million from the lower backlog conversion rates.
Paul Coster
And nothing that you said translates into better visibility regarding the first-half 2018 and the recovery in hardware and attached software question?
Mark Benjamin
I mean, it’s a little early, Paul, and certainly, I don’t want to make the same mistake perhaps, but we’re not going to talk about our 2018 guidance quite yet. We do expect to end the fourth quarter with a backlog that is up into the year.
And we do feel that the comps obviously will become easier for NCR in 2018. But we continue to stay very focused on our sales execution, our order growth, while certainly we’re disappointed in adjusting as we have in the fourth quarter to the numbers that Bob just shared.
We believe our 2018 will get going and we’ll move in with a – within our backlog.
Bob Fishman
Yes. And just to reinforce what Mark just said.
When we look at the ATM business going into 2018, there’s a number of factors that suggest that we have more confidence in the year. I look at it as in 2017, we were coming off a 2016 year, where ATMs were up 5%.
In 2017, ATMs will be down roughly 20%. So the compare going into 2018 is significantly better.
In addition and the push outs that we mentioned in North America into 2018 will help as we work through the year. The Windows 10 should be an accelerator for us in the back-half of the year from an ATM perspective.
We also have our 80 Series start to ramp. The 80 Series is orderable today in 33 countries and another 16 countries are in progress.
And then finally, there are a number of new product introductions that will help increase demand. So again, those are some of the reasons why we feel ATM business will be stronger in 2018.
Paul Coster
Okay. Thank you.
Operator
[Operator Instructions] We’ll take our next question from Katy Huberty with Morgan Stanley. Please go ahead.
Katy Huberty
Thanks. Good afternoon.
Just following up on the ATM deal delays, could you specifically address what you think is going on in North America? It just seems a bit odd that bank earnings and stock prices are expanding and yet they’re deciding to delay deals despite the fact that they’re committed to these project.
So what’s the communication you’re getting from customers? Are they waiting for regulatory change, or interest rate increases, or something to dislodge the budgets?
Are they sort of stuck in the mud around branch transformation planning, just any color around why you think North America budgets are coming through in the ATM space? And then I have a few follow-ups.
Mark Benjamin
Sure. Okay, Katy, this is Mark.
So I mean, I think, you mentioned many of the reasons impacting specific financial institutions. As you know, we do business with really all of them.
I would say, in large part, there is a slowness around what they’re focused on in their own businesses today, some are going through some restructurings of their own, some are under other pressures. So, we continue to work with those customers, we continue to drive revenues, we continue to convert existing backlogs, but there is certainly, I still think some sense around policy within the U.S.
I think there is a number of distractions taking place that have slowed some of the spending down on the retail side.
Katy Huberty
Okay, and then if you just think longer-term, you just had a quarter where ATM orders were weak, slow down in self check out and you missed the software license number, which speaks to the attach between the hardware and the software and ultimately the services businesses, do you think you can grow revenue if hardware doesn’t recover or the attach between the three businesses just so great that you absolutely have to grow revenue in order to grow the overall top line?
Mark Benjamin
Yes, I’ll start Katy with the answer and then I’ll hand it off to Paul to cover some of the software aspects, but I want to read into this as an overall NCR story, our sub check out business while under a tough comp and perhaps a little lighter quarter than we expected, we have great visibility into that business into the pipe as far as order growth, as well as backlog and we continue to essentially be the market leader with very strong share that continues to do well in our retail space. Our point of sale hardware business, the results are quite impressive in the quarter.
We mentioned our optic solution that gets included with our point-of-sale solution, an entire new industry for NCR that addresses the four quarter a PCR space, so I think we can continue to grow. I think certainly the ATM pressure is quite high and as you mentioned accurately, the attach rate of software that flows through any of our ATM miss obviously impacts the ability of the business to grow.
So I’ll let Paul touch on some of the software mix of attached and unattached and as he sees fit.
Paul Langenbahn
Yes, thanks Mark. Katy, one of the things that I’m actually very encouraged about is the year-to-date growth in our unattached software business which now accounts year-to-date for around two-thirds of our software license, so compare that back just a few years ago, it was more like one-third, so that’s kind of flipped which shows the degree to which NCR has become less dependent on the ATM and markets to grow our other revenue streams.
I look at our cloud business think of that last year as a low double – low single digit grower, accelerating to mid-to-high single digits this year and we’re pretty confident it’s on its way to double-digit growth that’s completely disconnected from the ATM business and even our professional services had a really good kind of mid-single digit grower quarter. So we are growing a number of revenue streams that happen to be our highest profit revenue streams in the business and the way I think about it is, we continue to transform the company these revenue streams become more and more important and the ATM business becomes more of a nice to have for us.
So I’m encouraged, it’s a little hard to see in the overall business right now, but I’m really encouraged with how the parts of the software business that aren’t connected to the ATM are performing.
Mark Benjamin
I would agree with that Katy, just to add a little bit more information to it. There’s a lot of pieces that have done very well this year, it’s really isolated to an ATM business that’ll be down close to 20% and then on unattached – I’m sorry, in attached software license number that’s also roughly down 20%.
So if you believe some of the things I mentioned a couple of minutes ago around the ATM business doing better in 2018, call that low single digits, then the attached software revenue improves and then you are left with all of the things Paul mentioned, the services margin expansion, that cloud margin expansion, the software maintenance margin expansion and we can get back on track.
Katy Huberty
Okay, thanks and just two other quick ones, I’ll ask them together. Bob, if you could give us the year-on-year backlog change for ATMs, SCO and point-of-sale that would helpful.
And then services margins were up 460 basis points year-on-year which is great and you’ve had a few quarters in a row of the trend, so it seems sustainable, but is it possible to break down that margin expansion between how much is the just mix shift to annuity with higher margin, which might move around quarter-to-quarter versus how much of that 460 basis points was structural actions that you’ve taken to drive efficiency in the business?
Bob Fishman
Yes, sure. So we entered Q3 with backlog down roughly.
We entered Q4, I should say, with backlog down roughly 1%. We’ll end the year with backlog up, so again that positions ourselves well for the start of the year.
On the hardware, think of hardware as being roughly flat, but you’ve got ATM – I’m sorry, hardware backlog being roughly flat, in that you’ve got a very strong backlogs in self checkout and point-of-sale. And then lower backlogs to support the ATM business, which is why we’re seeing the decline in the Q4 for ATMs.
But overall the good news is backlog up going into 2018. On the services margin, I would say that we’re having more sustainable change in services margin around a lot of the programs that we’ve been investing and I’ll let Mark speak to the M1 program is what we call it internally, but these are things around remote predictive, a lot of the technology investments we’ve made, so really the mix of services revenue to higher value services will help, but it’s more of the cost structure that’s driving the margin improvement now.
Mark, did you have anything further to add around M1?
Mark Benjamin
No, I think you took all of the good comments on M1, but Katy I think it’s a very good question and we have seen sequential improvements quarter-after-quarter with our services margin, as well as the growth on the revenues there. I would repeat what Bob said that it’s largely around our efficiency programs, perhaps now a term you’ve heard twice in call, what we refer to internally as M1, it stands for Mission 1, it’s really taking a very part of NCR’s business and really modernizing it with how we face our customer base, how we service them, the efficiency and the cost that they drive for the business and provide upside.
It’s still early days on managed service quite honestly. We think we have a very good opportunities ahead to continue to grow revenues with a fully outsourced managed service, but again as Bob mentioned, it’s largely just I think really our programs around modernizing our services infrastructure and the way we go to market.
Bob Fishman
I think the final comment I would make around backlog is, we are looking more at comprehensive backlog which would include our cloud business, our file value and when we look at all of the pieces, we’ve got roughly 60% to 65% of our revenue cover starting the year. So, as we drive more recurring revenue that’s captured in our file value in our enterprise ACV and that’s a good starting point for us.
Katy Huberty
Thank you.
Operator
Our next question will come from Ian Zaffino with Oppenheimer. Please go ahead.
Unidentified Analyst
Hi guys, thanks for taking the question, this is Mark on for Ian. So I guess most of my question has been answered.
So in regards to just sort of quickly on the backlog again, there is I guess delays driven by, I guess delays in the rollout of the volumes that are set to be shipped or I guess like more of volumes that hasn’t really materialized yet, thank you.
Bill Nuti
Yes, so I’ll let Bob perhaps give you more of a digital answer on the backlog. So Mark, the backlog really is part of the challenge we face as far as the pace in which that coverts to revenues and we’ve mentioned this in previous quarters.
Within the quarter we also have a segment of our orders that we actually build within the same – in the same time that we sell them. So it’s really a combination of the backlog conversion plus the orders that actually create revenues at the same time that we sell them, so it’s really a combination of the two.
And you want to add Bob any of digital component or breakdown of that?
Bob Fishman
I would just add to put numbers to that, I would go back to what I said at the of beginning of the of the Q&A. The orders came down for the full year, roughly $330 million, there was $150 million of revenue impact associated with that and then from a backlog conversion rate think of $50 million, so that gives you the drop in the midpoint of our guidance.
Unidentified Analyst
Okay got you, that’s very helpful. And then just a quick follow-up I guess like in terms of I guess capital allocation and free cash flows and is there any I guess like updates given that free cash flow is down a bit from previous guidance?
Thank you.
Bob Fishman
Yes, from a free cash flow perspective we’re guiding to 90% to 95% of adjusted net income which would be a $440 million to $470 million, we’ll drive a lot of cash flow in the fourth quarter, we’re confident that we’ll achieve those numbers. One is last year we drove $450 million of free cash flow in the fourth quarter compared to $400 million this year, so based on that it looks very achievable.
My AR balance is also higher, going into Q4 this year versus last year. When I look at the working capital metrics, they are very consistent with what we’ve done in the past.
And then throughout the year we’ve implemented a number of process improvements within quota cash, which include getting our bills out the door more timely and more accurately, being able to improve on our services billings, improve linearity in fourth quarter is going to help us, as well as teaming with the sales teams on some of these large accounts, so we feel good about the free cash flow that we’ll drive in the fourth quarter, I realized the 90% to 95% is a little over than what we guided we’ll get back to 95% to 100% in 2018, the challenge for me in the fourth quarter is not enough time to course correct to get back to that rate, but still pleased with the 90% to 95%. What will we do with that free cash flow?
We’ll continue to maintain a balanced capital allocation strategy. I think the good news is there’s lots of options for the board, we have a $300 million authorization program that’s out there that gives the Board a lot of opportunity to repurchase shares if they would like, so again a lot of flexibility from that perspective.
Unidentified Analyst
Okay, great, thank you very much.
Operator
Our next question will come from Kartik Mehta with Northcoast Research. Please go ahead.
Kartik Mehta
Bob, I was hoping you might dig into the service revenue a little bit. I was trying to figure out what percentage of your servicing revenue today is implementation revenue, for the ATM business?
Bob Fishman
Implementation, yes, implementation revenue or another way installation revenue is roughly 20% of our services business, so that’s the installation piece that’s more one-time in nature.
Kartik Mehta
So if you look at the service revenue that was down about 15% I think for the quarter for the ATM business, is that all related to the fact that you just had fewer machines to install?
Bob Fishman
And you are looking at which piece Kartik?
Kartik Mehta
Just I was just looking at the service revenue for the ATM business. I was just trying to figure out why the service revenue.
Mark Benjamin
Kartik, this is Mark. So without having that the numbers you’re looking at, but there is a relationship that obviously you’re seeking to that directly ties into ATM hardware and what we refer to as transaction services, which is the implementation, so the answer is yes.
The other way Kartik and I’m not sure where you are getting the TS yet, but the overall services revenue was actually up 3% in Q3, now we’re guiding to roughly flat in Q4 and that is because of the installation revenue being lower because of the ATM business.
Kartik Mehta
And then Mark, I just wanted to get your comments on the Middle East, were you saying that maybe the market is growing, but you decided not to participate because it was too competitive and it would have been not the margins you were looking for in the ATM business or in the Middle East Africa, just the ATM market is – overall ATM market is down?
Mark Benjamin
Yes, no, so it’s hard to really I think totally break down deal by deal Kartik. We did see overall order softness in the Middle East and Africa.
We remain very aggressive in those parts of the world. My comment is really around chasing the right profitable deals is that as you know our strategy is being to attach higher-margin recurring revenue, software, professional services, by the way maintenance services when we have the chance to sell hardware and I’d say that we did see a little bit of opportunities that we didn’t pursue that didn’t have those traits if you will.
So to sell ATM at a loss without being able to attach services or software really is not the business that we’re in or chasing today. So that does put a little bit of pressure on the orders, but quite honestly it’s not something new for us and it just added I think in a tough quarter a little more pressure.
Kartik Mehta
And then just one last question Mark. I just want to go back to your original statement to make sure I heard you right.
Would it be fair to say that these large orders that they are delays and they are not cancellations at this point in time, is that a fair statement you think for the ATM orders?
Mark Benjamin
Yes Kartik, I think that’s very fair. These customers continue to be very good customers of NCR as we continue to service them very well.
Our quality is very high, the 80 Series that we’ve mentioned throughout the call is a very exciting opportunity for our large customers and mid-sized and regional customers really worldwide today. Our services quality, so part of the margin improvements that we are seeing in services is the continued relationships with our customers, the value that we’re providing at high quality.
So, again it’s disappointing and we’re certainly looking forward and driving the right programs, but the customers really remain very committed to NCR.
Kartik Mehta
Thank you very much.
Operator
Our next question will come from Dan Kurnos with The Benchmark Company. Please go ahead.
Dan Kurnos
Great thanks. Just a quick housekeeping question on the software side, just looking at the guide for Q4, even bringing down attached 35% as you have in the deck, there is still some delta there to the downside, I know you guys talked about some licenses getting pushed out into Q4, I’m wondering if you know on the – maybe on the unattached side if there’s some delays there or if it’s just some flow-through from the other pieces of the business that you already called out?
Paul Langenbahn
Yes Dan, this is Paul, I’ll take that. We talked in earlier call about having $15 million of unattached pushing to the back half, our goal was to see half of that in Q3 and that did materialize, in Q3 we had a pretty tough compare there, we were up 26% of last year.
So I think I mentioned earlier 17% year-on-year, we expect to wind the year up in the unattached side in about that range. So it really is overwhelmingly in attached and attached to ATM story for us in terms of our guidance that’s the big challenge for us.
Bob Fishman
Yes, I would add to that unattached. We’ll have a good quarter, Dan.
Professional Services, because it can be tied somewhat to the ATM business will likely be roughly flat in the quarter.
Dan Kurnos
Got it. That’s helpful.
Thanks for that. And then just higher-level, maybe if you guys could give a little bit more color, I know you talked about having good visibility in SCO, but just sort of what the softness was there just in the quarter?
And we have seen some smaller independents making some inroads in QSR, particularly in self-serve and SCO. And so I’m just wondering, how you’re sort of seeing some of the larger logos going with either some smaller players.
And how you’re going to sort of maybe try to attack that marketplace, which still seems like a good opportunity for you guys?
Bill Nuti
Yes, so we appreciate the question. So just on the self-checkout question, again, I won’t read really anything into the quarter, it was a little lighter than we expected.
We’ll get back to kind of that $100 million or so run rate next quarter, and really going forward, we continue to truly have a great position there. On the QSR side, that business, our hospitality business has really been a darling for NCR for many years.
and we continue to really grow that business nicely. So, our solutions in the market are very competitive.
We serve the down market, which I think is probably part of your question, some of the new entrants. We serve that down market with a solution in NCR silver really where it’s a cloud solution, all online ordered and delivered.
So, we continue to obviously compete well. We have a great advantage in the market with our great customer base.
Paul, you want to…
Paul Langenbahn
Yes, I just, Dan, the other thing I’d mention is on the self-service aspect in the quick service restaurant markets, which you may have been referring to. We’ve got some really important new product introductions that are coming out.
So we’ve actually released our self-service software for quick service that’s being piloted by several brands you’d recognize today. And we also have a new product introduction that will hit early in the year on the Hardware side for self-service and quick-serve restaurants.
So we got all the customer relationships. We certainly got the heritage and the domain expertise around self-service.
And I think, as you see that market continue to develop in the restaurant space, expect NCR to be an important player there as well.
Bob Fishman
Yes. And just to attach some numbers to it, you remember, Dan, that the SCO business grew 88% last year.
It has the opportunity here to grow high teens for the year. So again, another good SCO year in 2017.
Dan Kurnos
Got it. That’s helpful.
And then, I don’t know if this is the right question asked now and sort of in light of sort of your commentary. Obviously, when we spoke last, Mark, we were talking and I know you’ve talked about this in the past about thinking about end of licensing products and product cycles.
I don’t know if this is sort of the landscape has changed the way you’re going about that or if there are still certain verticals where you think you can kind of juice either Hardware or Software sales as you consider, as you continue to kind of right-size your product portfolio?
Mark Benjamin
Yes. No, I appreciate that Dan, and certainly, we are committed to good end of life narrowing our product suite and making the right investments and we have discussed that.
I would say that, the energy around proper PLM and end of life is gaining momentum here. Certainly as we navigate the rest of the year, you’ll certainly hear more about that from NCR really in the first quarter.
I’d imagine at a potential Investor Day, where we could cover that in greater detail. But certainly, the disappointment we have here with the changed guidance, I think, is in some ways a good wake up call for many of us here at NCR is really to accelerate the programs around narrowing investments that perhaps is on end of life solutions, or legacy solutions and really focus more narrowly on our strategic platforms for the future.
Dan Kurnos
All right, great. Thanks, guys.
Mark Benjamin
All right.
Operator
We’ll take our question from Matt Summerville with Alembic Global Advisors.
Matt Summerville
Thanks, I have two or three questions here. Bob can you help me square up your comments and orders.
So basically you had a $100 million coming out of the book for Q3 $230 million out of Q4. How are you going to end with a year-over-year higher backlog?
And I guess to my next point, you have the opportunity in open forum now to sort of talk about the early part of 2018 given that the backlog orientation of the ATM business does that not mean that you guys will have a relatively soft start to 2018, isn’t that how we should be thinking about it at this point?
Bob Fishman
Yes on those two questions, you’ll remember Matt last year orders grew 46% in the fourth quarter even with the $230 million bring down in the fourth quarter, orders will be slightly down. And then when you combine that with the revenue being down, the math ends up saying backlog up going into the year.
So again, facing a really tough order compare and being able to start the year with backlog up. I don’t think we want to comment at this point around or what Q1 or Q2 looks like.
I will just reiterate that the ATM business will not be down 20% next year. We’re looking right now low single-digits perhaps better that then allows the attached software revenue to grow.
In addition to that all of the good things we talked about cloud starting to grow double-digits unattached software license over the two-thirds of our software license and that’s growing mid teens. You’ve got to self check out in the point-of-sale business that continued to have a lots of market demand.
So again, for me, 2017 is disappointment with an ATM and attached software. It won’t be nearly that bad in 2018 and we’ll have the backlog that we need to start the year to set us up for where we want to be.
Matt Summerville
And then something else you guys can maybe square up for me, in light of I think Mark’s comment about making sure you guys chase profitable deals, on a sequential basis your hardware revenues were up then but your operating profit goes from being positive to a loss. If I even look on a year-over-year basis, you’re down 40% in revenue, down 30% in profit.
The detrimentals are huge. So what isn’t working in the hardware business?
Is it mix? Is it a bunch of money you are pouring into new products?
What is the issue here with profitability?
Bob Fishman
It comes down to mix. We’ve talked before a little bit about the mix of a big customer smaller customers, country, regional mix, SCO versus point-of-sale versus ATM.
So again that is our issue mix in this particular quarter.
Bill Nuti
Yes, Matt, it’s also…
Matt Summerville
I’m sorry…
Bill Nuti
…it’s also I think as Bob is alluding to, just not to miss it’s really also around volume. So you know a significant near-term disappointment will drive obvious pressures on cost relative to volume.
As we’ve said in previous quarters, we really turned over most of our solutions over the past call it year. So, new product introductions really across all of the markets we serve tend to add cost certainly when the volume doesn’t materialize that you expect.
So just sort of some pressures included with what Bob mentioned.
Matt Summerville
And again, just one more point to maybe Paul’s question earlier in the call. Coming out of Q2 in early July you have the number one ATM player in North America significantly take down guidance calling talking about a lot of the same things you’re talking about.
You spend a lot of time on your second quarter call trying to sort of a late year has convince everyone and then maybe this was an industry sort of issue. I guess I’m trying to understand between late July and the end of September, what specifically happened.
What customer conversations were you having then did all of the sun just disappeared? I guess at the end of the day, I don’t know why you guys just didn’t take a pretty good hair cut to your numbers last quarter.
I’m confused why this is happening now. I guess, at the end of the day is my comment and/or question?
Mark Benjamin
Matt, listen, I think it’s a fair question, so we’ll do our best to tell you why that was the case. Within the third quarter, we had some order weakness to the tune, as Bob highlighted, to $100 million.
And while that’s significant, it doesn’t necessarily materialize at the beginning of a quarter. So these orders take place throughout the quarter and in fact, certainly, when it comes to Hardware, we tend to see, it happen later in the quarter.
Our pipelines and the sales force confidence was still high at that point as far as achieving the quarter, but they missed. And then we rolled up our forecast, essentially, Matt, last week for the fourth quarter, and obviously had some surprises with what we would see throughout the fourth quarter.
We [indiscernible] we we have a lot of respect for. We don’t consider them a proxy for our business whatsoever.
We consider ourselves far more diversified as a company. In fact, more than 50% of our revenues today are non-ATM or non-financial services-related revenues.
So I think we’re a very different business. We obviously are disappointed, but nothing in July or August that we saw in the business relative to your question on a competitor’s our results are really changed our confidence and execution.
I think, by the way while we’re disappointed in the results in the quarter, we had a significant miss certainly now for the full-year in ATMs. But we’ll still perform nicely on other parts of the business.
Well, I’m not so sure that if we were exclusively an ATM business, we’d be able to succeed that way. So hopefully, I’m answering your question, Matt.
Happy to take a follow-up.
Matt Summerville
I’m good for now. Thank you.
Mark Benjamin
Okay.
Operator
That does conclude today’s question-and-answer session. Mr.
Mark Benjamin, at this time, I will turn the conference back to you for any additional or closing remarks.
Mark Benjamin
Okay. Well, I just wanted to thank everyone for joining us today.
And again, while we’re disappointed in the results and the change of our full-year guidance here in the fourth quarter, we remain incredibly confident in our strategic priorities, our market position and the support we get every day from our great customers and our 33,000 NCR associates. So thank you for joining us today.
Operator
This concludes today’s conference. Thank you for your participation.
You may now disconnect.