NCR Corporation reported financial results for the three months ended March 31, 2018. First quarter highlights include:

• Revenue of $1.52 billion, up 3% as reported, above previously provided guidance

• Software revenue up 2% driven by cloud revenue growth of 9%

• GAAP diluted EPS of $0.35; Non-GAAP diluted EPS of $0.56, above previously provided guidance

• Services revenue up 8% and gross margin expansion of 230 basis points

• $165 million of share repurchases completed in Q1 of the previously announced $300 million

• 2018 guidance reaffirmed

“I am honored to be the CEO of this great company,” said Michael Hayford, whose appointment as President and Chief Executive Officer was announced on April 30, 2018. “NCR is a global leader in providing software-led technology solutions for the financial services, retail and hospitality markets, and has a long history of driving innovation. We are well positioned to extend our leadership position by further evolving into a software-led technology company, and I am excited to capture the growth opportunities that we have ahead of us.”

“The first quarter marked a solid start to the year, with results that place us on track to achieve our full year financial and operating targets,” said COO Paul Langenbahn. “Cloud revenue increased 9% and we generated healthy net ACV, which demonstrates our global software leadership and our market-leading innovation. We also maintained our focus on driving continuous improvement in our business model and accelerating our operational transformation by recently initiating a process to restructure our Hardware business by simplifying our manufacturing network to best position the business for improved profitability in the years ahead. At the same time, we are focused on capturing efficiencies across our organization, including in Services where our transformation initiatives continue to improve top-line growth and drive strong margin expansion.”

In this release, we use certain performance metrics as well as certain non-GAAP measures, including presenting certain measures on a constant currency basis. The performance metrics include net annual contract value (or Net ACV) and the non-GAAP measures include free cash flow and others with the words “non-GAAP,” or “constant currency” in their titles. The performance metrics are listed and described, and the non-GAAP measures are listed, described, and reconciled to their most directly comparable GAAP measures, under the heading “Performance Metrics and Non-GAAP Financial Measures” later in this release.

First Quarter 2018 Operating Results

Revenue
First quarter revenue of $1.52 billion was up 3% year-over-year. Foreign currency fluctuations had a favorable impact on the revenue comparison of 3%.

The following table shows the revenue by segment for the first quarter:

Software revenue was up 2% driven by cloud revenue growth of 9% and professional services revenue growth of 8%. Software license revenue declined 18% due to lower Hardware revenue, the timing of large software transactions in the prior year and the beginning of a shift from software license revenue to cloud revenue. Net ACV was $18 million in the first quarter of 2018.

Services revenue was up 8% driven by hardware maintenance and implementation services growth as a result of continued momentum in managed service offerings and channel transformation trends.

Hardware revenue was down 3%. ATM revenue declined 7% as expected and reflected the lower backlog starting the quarter. SCO revenue declined 24% due to the timing of customer rollouts. POS revenue continued its momentum and increased 19% in the quarter due to store transformation trends.

Gross Margin
First quarter gross margin of $420 million was up from $412 million. Gross margin rate was 27.7%, down from 27.9%. First quarter gross margin (non-GAAP) of $431 million was flat with the prior year. Gross margin rate (non-GAAP) was 28.4%, down from 29.2%. The decrease in gross margin rate (non-GAAP) was primarily due to lower software license revenue and lower Hardware margins, which were partially offset by continued focus on productivity improvements in our Services segment.

Expenses
First quarter operating expenses of $311 million increased from $297 million. First quarter operating expenses (non-GAAP) of $283 million increased from $273 million. The increases in expenses were due to increased sales investment as we expand our strategic offers and go-to-market strategy.

Operating Income
First quarter operating income of $109 million decreased 5% from $115 million. Operating margin rate was 7.2%, down from 7.8%. First quarter operating income (non-GAAP) of $148 million decreased 6% from $158 million. Operating margin rate (non-GAAP) was 9.8%, down from 10.7%. Operating margin rates reflected lower software license revenue, lower Hardware margins and increased sales investment, and were partially offset by continued Services margin expansion.

Other (Expense)
First quarter other (expense) and other (expense) (non-GAAP) of $46 million increased 5% from $44 million compared to the prior year.

Income Tax Expense
First quarter income tax expense of $7 million decreased from $14 million. The first quarter effective income tax rate was 11% compared to 20% in the prior year. First quarter income tax expense (non-GAAP) of $16 million decreased from $27 million in the prior year. The first quarter effective income tax rate (non-GAAP) was 16% compared to 24% in the prior year. Income tax expenses decreased due to lower income before taxes in the quarter, favorable audit settlements and the impact of U.S. Tax Reform. Income tax expense included a favorable audit settlement that was previously anticipated in the second quarter which provided an $0.08 benefit to non-GAAP diluted earnings per share in the first quarter of 2018 versus our previous guidance.

Net Income from Continuing Operations Attributable to NCR
First quarter net income from continuing operations attributable to NCR of $55 million decreased from $57 million in the prior year. First quarter net income from continuing operations attributable to NCR (non-GAAP) of $85 million decreased from $87 million in the prior year.

Cash Flow
First quarter cash used in operating activities of $24 million decreased from cash provided by operating activities of $39 million in the prior year. Free cash outflow was $99 million in the first quarter of 2018 as compared to free cash outflow of $16 million in the first quarter of 2017. Free cash flow was negatively impacted by the timing of cash collections and higher inventory. Inventory balances increased to support higher Hardware revenue in the back half of the year and to transition to our new manufacturing strategy.

Share Repurchase Program

During 2018, NCR plans to repurchase up to $300 million of its common stock under its previously authorized share repurchase programs, and repurchased shares of its common stock for approximately $165 million during the first quarter.

Other Items

Following a March 2018 court decision in the previously reported litigation concerning alleged environmental contamination at the Kalamazoo River, the Company has recorded a charge of approximately $35 million, net of tax, included as discontinued operations. The Company will appeal an interim 2013 decision as well as the 2018 decision; if the appeal of the 2013 decision is successful the Company’s liability would be eliminated and the charge will be reversed. Significant cash expenditures on Kalamazoo River remediation are not expected to be incurred until the early to mid-2020s, as remedies have not yet been determined for much of the remediation project.

Full Year 2018 Outlook

We are reaffirming our full year 2018 guidance. Our revenue growth is expected to be 0% to 3%. Our GAAP diluted earnings per share is expected to be $2.08 to $2.48, and our non-GAAP diluted earnings per share is expected to be $3.30 to $3.45. Our non-GAAP diluted earnings per share guidance assumes an effective tax rate of 24% for 2018 compared to 25% in 2017. The decrease is due to the expected impact of U.S. Tax Reform. Free cash flow is expected to be approximately 90% of non-GAAP net income.

To accelerate our transformation journey, we are evaluating and beginning to implement programs to prioritize driving sustainable margin improvement in our Hardware and Services segments targeted at driving higher productivity, process efficiency, and the use of technology as an enabler. As we finalize and execute on these programs, NCR expects to incur a related pre-tax charge over the next two years in the range of approximately $200 million to $250 million, with $100 million to $150 million in 2018, that will be included in income from operations. The cash impact of these transformation initiatives is expected to be approximately $150 million to $200 million over the next two years, with $100 million in 2018. We plan to achieve run-rate savings of approximately $150 million per year by 2020. The estimate of the pre-tax charges and cash impact has been included in our 2018 GAAP diluted earnings per share and free cash flow guidance. In the first quarter of 2018, we incurred a $16 million pre-tax charge and $14 million of cash payments relating to these initiatives.

Q2 2018 Outlook

For the second quarter of 2018, revenue growth is expected to be down 1% to up 1%, GAAP diluted earnings per share is expected to be $0.12 to $0.30, and non-GAAP diluted earnings per share is expected to be $0.60 to $0.65. Income from operations includes an estimated pre-tax charge of $40 million to $60 million in the second quarter of 2018 related to the transformation initiatives described above.