The Daily Magic Formula Stock for 12/01/2008 is NCR Corp. According to the Magic Formula Investing Web Site, the ebit yield is 22% and the EBIT ROIC is 25-50 %.
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NCR Corporation and its subsidiaries (NCR or the Company, also referred to as â€śweâ€ť, â€śusâ€ť or â€śourâ€ť) provide technology and services that help businesses connect, interact and transact with their customers.
NCR Corporation is a leading global technology company that provides innovative products and services to help businesses build stronger relationships with their customers. Through our presence at customer interaction points, such as automated teller machines (ATMs), retail point-of-sale (POS) workstations, and self-check-in/out systems, our Financial Self Service and Retail Store Automation solutions enable companies to address consumer demand for convenience, value and individual service. Our Customer Services division provides support services for NCRâ€™s solutions as well as select third-party products.
NCR provides specific solutions for customers in a range of industries such as retail, financial, travel and hospitality, health care, entertainment and gaming, and public sector. NCRâ€™s solutions are built on a foundation of long-established industry knowledge and consulting expertise, value-added software and hardware technology, global customer support services, and a complete line of business consumables and specialty media products.
NCR was originally incorporated in 1884 and was a publicly traded company on the New York Stock Exchange prior to its merger with a wholly-owned subsidiary of AT&T Corp. (AT&T) on September 19, 1991. Subsequently on December 31, 1996, AT&T distributed all of its interest in NCR to its stockholders (the â€śDistributionâ€ť). NCR common stock is listed on the New York Stock Exchange and trades under the symbol â€śNCR.â€ť
On September 30, 2007, NCR completed the spin-off of its Teradata Data Warehousing business through the distribution of a tax-free stock dividend to its stockholders. NCR distributed one share of common stock of Teradata Corporation (Teradata) for each share of NCR common stock to NCR stockholders of record as of the close of business on September 14, 2007. Both companies are now independent and have separate public ownership, boards of directors and management. In addition, each company has direct access to capital markets to fund its growth agenda and can appeal to the investor bases who best understand, appreciate and value the respective businesses of the separated companies. To facilitate the spin-off, NCR and Teradata entered into commercial and other agreements with provisions that NCR will provide certain services to Teradata for a specified period of time. These agreements are not considered to result in significant continuing involvement in the Teradata operations.
For more information regarding the spin-off refer to Managementâ€™s Discussion & Analysis (MD&A) in Item 7 and Note 12 of the Notes to Consolidated Financial Statements, â€śDiscontinued Operations,â€ť in Item 8 of Part II of this Form 10-K report (Report).
NCR operates in the information technology industry. As of January 1, 2008, NCR began management of its businesses on a geographic basis changing from the previous model of global business segments. This change to NCRâ€™s segment reporting for fiscal year 2008 and future periods is further described in Note 14 of the Notes to Consolidated Financial Statements, â€śSubsequent Event,â€ť in Item 8 of Part II of this Report. For the year ended December 31, 2007 and the prior year periods reported in this Form 10-K, NCR categorizes its continuing operations into five reportable segments: Financial Self Service (which includes the Companyâ€™s ATM business), Retail Store Automation, Customer Services, Systemedia, and Payment & Imaging and Other. Each segment generally integrates hardware, software, and professional and installation-related services, and is described below.
Revenue by segment as well as geographic information is reported in Item 8 of Part II of this Report as part of Note 13 of the Notes to Consolidated Financial Statements, â€śSegment Information and Concentrations,â€ť and is incorporated herein by reference.
Financial Self Service Segment
Products and Services
Our Financial Self Service business provides financial institutions, retailers and independent deployers with financial-oriented self service technologies, such as ATMs, cash dispensers, and software solutions, including the APTRAâ„˘ application suite and consulting services related to ATM security, software and bank branch optimization. Financial Self Service solutions are designed to quickly and reliably process consumer transactions and incorporate advanced features such as automated check cashing/deposit, automated cash deposit, web-enablement, bill payment and the dispensing of non-cash items. Financial Self Service solutions enable businesses to reduce costs and generate new revenue streams while enhancing customer loyalty.
Target Markets and Distribution Channels
NCRâ€™s Financial Self Service solutions primarily serve the financial services industry with particular focus on retail banking, which includes traditional providers of consumer banking and financial services. Financial Self Service solutions also serve the retail markets through convenience banking products for retailers designed to complement their core businesses. Customers are located throughout the world in both established and emerging markets. NCR has historically sold most of its Financial Self Service products and services through a direct sales channel, although a portion of revenues is derived through distributors. About 80% of product and service sales in recent years were made by the direct sales force; the remainder is sold through indirect channels.
Our Financial Self Service business competes with Diebold, Inc. and Wincor Nixdorf GmbH & Co. (Wincor), among others, in markets where it operates. The primary factors of competition can vary, but typically include: value and quality of the solutions or products; total cost of ownership; industry knowledge of the vendor; the vendorâ€™s ability to provide and support a total end-to-end solution; the vendorâ€™s ability to integrate new and existing systems; the fit of the vendorâ€™s strategic vision with the customerâ€™s strategic direction; and the quality of the vendorâ€™s support and consulting services.
Retail Store Automation Segment
Products and Services
Retail Store Automation provides retail-oriented technologies such as POS terminals, self-check-in/out systems, self-service kiosks, bar-code scanners, software and services to companies worldwide. Combining our retail industry expertise, software and hardware technologies, and implementation and store performance consulting services, our Retail Store Automation solutions are designed to enable cost reductions and improve retailer operational efficiency while increasing satisfaction of the retailerâ€™s customers.
Target Markets and Distribution Channels
NCR delivers Retail Store Automation solutions for the general merchandise, food and drug, travel and hospitality, health care, entertainment and gaming, and public sector segments. The general merchandise segment includes department stores, specialty retailers, mass merchandisers and catalog stores. The food and drug segment includes supermarkets, hypermarkets, grocery, drug, wholesalers and convenience stores. The hospitality segment includes fast food/quick service/table service, other restaurants and lodging. About 90% of NCRâ€™s Retail Store Automation solutions are sold through a direct sales force, with the remainder sold through alliances with value-added resellers, distributors and dealers. NCR has focused its investments and resources on self-service technologies with expanded offerings to include self-ticketing and self-check-in/out systems for the travel industry, including airlines, car rentals and hotels, self-service food/deli ordering and patient management check-in/out in the health care sector.
NCR faces strong competition in the retail industry in all geographic areas where it operates around the world. The Company believes that key competitive factors can vary by geographic area but typically include: value and quality of the solutions or products; total cost of ownership; industry knowledge of the vendor; and knowledge, experience and quality of the vendorâ€™s consulting, deployment and support services. NCRâ€™s competitors vary by market segment, product, service offering and geographic area, and include IBM, Wincor, Fujitsu, Hewlett-Packard Company, Dell Inc., Metrologic Group and PSC Inc., among others.
Customer Services Segment
Customer services are an essential and integrated component of NCRâ€™s complete solution offerings. The Customer Services Division provides maintenance and support services for NCRâ€™s Financial Self Service, Retail Store Automation and Payment & Imaging and Other businesses, as well as for select third-party companies. Our Customer Services operating segment provides other services including site assessment and preparation, staging, installation and implementation, and complete systems management. The Customer Services operating segment also includes the resale and service of third-party computer hardware from select manufacturers, such as Cisco Systems, who value and leverage NCRâ€™s global service capability. However, NCRâ€™s strategy is to focus primarily on maintenance and support of NCR-branded products in order to capture higher margin services and significantly reduce redundant costs associated with supporting/servicing multiple third-party products.
Target Markets and Distribution Channels
The focus of our Customer Services business is to provide service for NCRâ€™s other solutions. However, Customer Services is also pursuing managed service relationships with its key customers. Longer term managed service arrangements serve to improve the efficiency and performance of the customerâ€™s business, and increase the strategic and financial importance of its relationship with NCR. We also can and do provide services on competing technologies used in these segments â€“ for example, IBM retail technologies and Diebold ATMs. The primary sales channel for Customer Services is NCRâ€™s direct sales teams, which exist in all NCR operating segments. Our Customer Services team provides these services directly to end customers.
NCR faces competition for customer services from other technology providers, as well as from service-only firms, in all geographies where it operates around the world. The primary Customer Services competitors are the companies identified in NCRâ€™s other solutions. Global technology providers are becoming more focused on services as a core business strategy. NCR also competes with a range of smaller regional and local service companies that differ by geography.
Systemedia develops, produces and markets a complete line of printer consumables for various print technologies. Systemedia products include paper rolls for receipts in ATMs and POS solutions, inkjet and laser printer supplies, thermal transfer and ink ribbons, labels, laser documents, business forms, and specialty media items such as photo and presentation papers, and two-sided thermal paper. Systemedia products are designed to optimize operations and improve transaction accuracy, while reducing overall costs.
Target Markets and Distribution Channels
The major industries targeted by Systemedia include retail, transportation, financial services and manufacturing. Systemediaâ€™s direct sales organization focuses on providing comprehensive solutions to customers in 26 countries. In addition, Systemedia products are sold through various channel partners including office product retailers, contract stationers, value-added resellers, original equipment manufacturers as well as through telemarketing and the internet.
Competition in the printer consumable and media solutions industry is significant and varies by geographic area and product group. The primary areas of competitive differentiation are typically quality, logistics and supply chain management, and total cost of ownership. While price is always a factor, Systemedia focuses on the customerâ€™s total cost of ownership for its products. Total cost of ownership takes into account not only the per-unit cost of the media, but also service, usage, reporting and support costs.
Payment & Imaging and Other Segment
Products and Services
Payment & Imaging provides end-to-end solutions for both traditional paper-based and image-based check and item processing. Payment & Imaging solutions utilize advanced image recognition and workflow technologies to automate item processing, helping financial institutions increase efficiency and reduce operating costs. Consisting of hardware, software, consulting and support services, our comprehensive Payment & Imaging solutions enable check and item-based transactions to be digitally captured, processed and retained within a flexible, scalable environment.
â€śOtherâ€ť business activity included in this segment primarily relates to a small business in Japan.
Target Markets and Distribution Channels
NCRâ€™s Payment & Imaging solutions primarily serve the financial services industry worldwide, with a major focus on banks. NCR has historically distributed most of its Payment & Imaging products and services through a direct sales channel, although certain revenues are derived through sales by value-added resellers and distributors. Approximately 85% of product sales in recent years were sold by our direct sales force; the remainder was sold through indirect channels.
NCR faces competition in the financial services industry in all geographic areas where it operates. The primary areas of competition can vary, but typically include: quality of the solutions or products; total cost of ownership; industry knowledge; the vendorâ€™s ability to provide and support a total end-to-end solution; the vendorâ€™s ability to integrate new and existing systems; the fit of the vendorâ€™s strategic vision with the customerâ€™s strategic direction; and the quality of the vendorâ€™s support and consulting services. NCRâ€™s competitors vary by product, service offering and geographic area, and include Metavante Corporation and Unisys Corporation, among others.
Research and Development
We remain focused on designing and developing products, services and solutions that anticipate our customersâ€™ changing technological needs. The expenses for research and development related to NCRâ€™s continuing operations were $137 million in 2007, $119 million in 2006 and $125 million in 2005. We anticipate that we will continue to have significant research and development expenditures in the future to provide a continuing flow of innovative, high-quality products and services to maintain and enhance our competitive position. Information regarding the accounting and costs included in research and development activities is included in Note 1 of the Notes to Consolidated Financial Statements â€śDescription of Business and Significant Accounting Policies,â€ť in Item 8 of Part II of this Report and is incorporated herein by reference.
Information regarding seasonality is included in Item 1A of this Report under the caption â€śOperating Results Fluctuations,â€ť and is incorporated herein by reference.
Sources and Availability of Raw Materials
Information regarding sources and availability of raw materials is included in Item 1A of this Report under the caption â€śReliance on Third Parties,â€ť and is incorporated herein by reference.
Patents and Trademarks
NCR owns approximately 1,400 patents in the United States and a significant number in foreign countries. The foreign patents are generally counterparts of NCR's U.S. patents. Many of the patents owned by NCR are licensed to others and NCR is licensed to use certain patents owned by others. While NCR's portfolio of patents and patent applications in aggregate is of significant value to NCR, the Company does not believe that any particular individual patent is itself of material importance to NCR's business as a whole.
NCR has registered certain trademarks and service marks in the United States and in a number of foreign countries. NCR considers the mark â€śNCRâ€ť and many of its other trademarks and service marks to be valuable assets.
On December 31, 2007, NCR had approximately 23,200 employees and contractors.
NCR makes available through its website, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, definitive proxy statements on Form 14A and Current Reports on Form 8-K, and all amendments to such reports, as soon as reasonably practicable after these reports are electronically filed or furnished to the U.S. Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. NCR will furnish, without charge to a security holder upon written request, the Notice of Meeting and Proxy Statement for the 2008 Annual Meeting of Stockholders (the 2008 Proxy Statement), portions of which are incorporated herein by reference. NCR will furnish the Code of Conduct and any other exhibit at cost. Document requests are available by calling or writing to:
1700 S. Patterson Boulevard
Dayton, OH 45479
Information regarding environmental matters is reported in Item 8 of Part II of this Report as part of Note 11 of the Notes to Consolidated Financial Statements, "Commitments and Contingencies," and is incorporated herein by reference.
MANAGEMENT DISCUSSION FROM LATEST 10K
NCR Corporation is a leading global technology company that provides innovative products and services to help businesses connect, interact and transact with their customers. Through our presence at customer interaction points, such as automated teller machines (ATMs), retail point-of-sale (POS) workstations, and self-check-in/out systems, our Financial Self Service and Retail Store Automation solutions enable companies to address consumer demand for convenience, value and individual service. Our Customer Services Division provides support services for NCRâ€™s solutions as well as select third-party products.
We provide solutions for retail, financial, travel and hospitality, health care, entertainment and gaming, and public sector organizations through our Financial Self Service (which includes our ATM business), Retail Store Automation, Customer Services, Systemedia, and Payment & Imaging and Other business segments. We deliver our solutions to customers on a global basis, and categorize our results into four regions: the Americas, Europe/Middle East/Africa (EMEA), Japan and Asia/Pacific. Our solutions are based on a foundation of long-established industry knowledge and consulting expertise, value-added software, hardware technology, global customer support services, and a complete line of business consumables and specialty media products. Starting January 1, 2008, NCR began management of its businesses on a geographic basis, changing from the previous model of global business segments. This change to NCRâ€™s management system, and therefore its segment reporting for fiscal year 2008 and future periods, is further described in Note 14, â€śSubsequent Event,â€ť of the Notes to Consolidated Financial Statements in Item 8 of Part II of this Report.
NCRâ€™s reputation has been built upon more than 120 years of providing quality products, services and solutions to our customers. At the heart of our customer and other business relationships is a commitment to acting responsibly, ethically and with the highest level of integrity. This commitment is reflected in NCRâ€™s Code of Conduct, available on the corporate governance page of our website.
Spin-off of Teradata Data Warehousing Business On September 30, 2007, NCR completed the spin-off of its Teradata Data Warehousing business through the distribution of a tax-free dividend to its stockholders. NCR distributed one share of common stock of Teradata Corporation (Teradata) for each share of NCR common stock to NCR stockholders of record as of the close of business on September 14, 2007. Upon the distribution of Teradata, NCR stockholders received 100% (approximately 181 million shares) of the common stock of Teradata, which is now an independent public company trading under the symbol â€śTDCâ€ť on the New York Stock Exchange.
In accordance with Statement of Financial Accounting Standards No. 144 (SFAS No. 144), Accounting for the Impairment or Disposal of Long-Lived Assets, the results of operations, assets, liabilities and cash flows of Teradata have been presented as a discontinued operation for all periods presented in this Report. See Note 12, â€śDiscontinued Operations,â€ť in the Notes to Consolidated Financial Statements in Item 8 of Part II of this Report for a further discussion of the spin-off of Teradata. Unless otherwise noted, this MD&A excludes information related to the Teradata Data Warehousing business.
2007 FINANCIAL OVERVIEW
As more fully discussed in later sections of this MD&A, the following were significant themes and events for 2007:
Revenue growth was driven by increases in Financial Self Service, Retail Store Automation and Customer Services, and
NCR successfully completed the manufacturing realignment initiative and the spin-off of Teradata (classified as a discontinued operation) on September 30, 2007, as described above.
In 2007, we continued our focus on our strategic initiatives to increase operating income and provide maximum value to our stakeholders. The initiatives and the results against them were as follows:
1) Drive profitable growth â€“ We invested in sales and other demand creation resources in areas with the greatest potential for profitable growth such as self-service technologies, including self-check-in/out and other self-service solutions. We continued to broaden the scope of our self-service solutions for our existing customers and to introduce these solutions into newer industry-vertical markets, such as travel and hospitality, health care, entertainment and gaming, and public sector. Additionally, we made acquisitions and investments that we believe will increase our market coverage and enhance our existing solution offerings.
2) Strengthen competitive position â€“ We are focused on increasing the efficiency and effectiveness of our core functions and the productivity of our employees. In 2007, we completed the transition of our high-volume ATM manufacturing from Scotland to Hungary that we began in the first quarter of 2007. In the Americas, our manufacturing outsourcing initiative with Flextronics (formerly Solectron) was completed as planned and we are in full production at Flextronics. In September 2007, NCR commenced a realignment program in Japan, which was primarily focused on the Customer Services business and includes actions which are designed to improve operating efficiency and strengthen the Companyâ€™s competitive position in Japan. The Company has been successful in executing the realignment program, as planned, and expects to realize the program benefits starting in 2008. The Company continues to evaluate other realignment opportunities that drive operating efficiency globally. Refer to â€śRestructuring and Re-engineeringâ€ť in this MD&A for more information regarding our manufacturing and Japan realignment initiatives.
3) Evolve to a more customer-focused, high-technology culture â€“ We focused on the traits and competencies necessary to enable us to deliver profitable growth and strengthened our competitive position. This was accomplished through organizational and people development, management system changes and alignment, and a stronger linkage between compensation and performance.
In the Consolidated Financial Statements and related Notes to Consolidated Financial Statements included in Item 8 of Part II of this Report, the Company revised the 2007 results previously released on January 30, 2008 and furnished under Form 8-K. Our previously released 2007 net income per diluted share was $1.45 per share as compared to $1.50 per share as shown in our Consolidated Financial Statements, and our previously released net income per diluted share for the fourth quarter of 2007 was $0.43 per share as compared to $0.48 per share as shown in Note 15, â€śQuarterly Information (unaudited)â€ť. The differences between the previously released results and those included in this Form 10-K primarily relate to the finalization of our income tax provision for the year ended December 31, 2007.
Building on our progress in 2007, our strategic initiatives in 2008 to increase operating income and provide maximum value to our stakeholders include:
1) Profitable revenue growth We expect to continue to optimize our investments in demand creation to increase NCRâ€™s market coverage in areas with the greatest potential for profitable revenue growth. We expect these investments to provide benefits in 2008 and beyond. We believe that NCR has growth opportunities in self-service technologies in our core industries of Financial and Retail as well as in the emerging industries of travel and hospitality, health care, entertainment and gaming, and public sector. We expect to grow our businesses organically as well as through targeted acquisitions and strategic partnerships.
2) Build a competitive cost structure The Company expects to focus on increasing the efficiency and effectiveness of our core functions and the productivity of our employees. Areas of emphasis are expected to include product development, manufacturing and supply chain, customer services delivery and our overall management system.
3) Optimize capital structure Starting in the fourth quarter of 2007, NCR resumed its share repurchase program, which is expected to continue in 2008 and beyond. In addition, the Company will make investments in areas that generate maximum growth, such as self-service research and development and demand creation. We believe that our current debt levels are appropriate and will help us maintain flexibility in the capital structure for any potential funding requirements.
The following forward-looking information is based on NCRâ€™s expected results, excluding Teradata, which is an independent company following its spin-off from NCR on September 30, 2007. We are projecting that the capital spending environment in 2008 could be slightly lower than what was experienced in 2007, and are forecasting NCRâ€™s 2008 revenue to be 3-5% higher than in 2007. We expect our 2008 operating income to increase due to a more favorable mix of revenue as higher-margin, self-service technologies increase as a percent of the total revenue. In addition, we expect pension expense to be at similar levels compared to 2007. Earnings expansion in 2008 should be more prevalent later in the year as we expect to launch new self-service solutions in the market and anticipate spending from financial institutions for deposit automation to increase later in the year.
Revenue changes in constant currency In the Americas region, revenue increases in Retail Store Automation and Customer Services were offset by declines in Systemedia and Payment & Imaging and Other. In the EMEA region, the revenue increase was driven by Financial Self Service, aided by increases in the Customer Services and Retail Store Automation businesses. In Japan, revenue increases in Retail Store Automation, Customer Services and Payment & Imaging and Other were slightly offset by a revenue decrease in Systemedia. Finally, in our Asia/Pacific region, a double-digit revenue growth was led by Financial Self Service along with growth in the Retail Store Automation, Customer Services and Systemedia businesses.
Revenue changes in constant currency In the Americas region, revenue declined in the Financial Self Service, Retail Store Automation, Customer Services and Systemedia businesses. In the EMEA region, increases in our Financial Self Service, Retail Store Automation and Payment & Imaging and Other businesses were partially offset by declines in Customer Services and Systemedia. In Japan, revenue increases in Retail Store Automation, Payment & Imaging and Other and Systemedia were offset by a decrease in the Customer Services business. Finally, in our Asia/Pacific region, the revenue increases were driven by growth in Financial Self Service, Retail Store Automation and Systemedia.
Revenue and Operating Income by Segment
Our key solutions are categorized as Financial Self Service, Retail Store Automation and Customer Services, each of which is a reportable segment. In addition, our smaller businesses are reported in the Systemedia and Payment & Imaging and Other segments. Our segments comprise hardware, software, and professional and installation-related services along with maintenance and support services in our Customer Services segment, as applicable.
NCRâ€™s segment results have been adjusted for the maintenance services business in Japan and corporate overhead expenses that were previously allocated to the Teradata Data Warehousing segment. These adjustments were not material to individual segment results for any of the current or prior years.
For purposes of discussing our operating results by segment, we exclude the impact of certain items from operating income, consistent with the manner by which management views each segment and reports our operating segment results under Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information . This format is useful to investors because it allows analysis and comparability of operating trends. It also includes the same information that is used by NCR management to make decisions regarding the segments and to assess our financial performance. The effect of pension expense, which was $38 million in 2007, $122 million in 2006 and $128 million in 2005, has been excluded from the operating income for each reporting segment presented and discussed below. In addition, manufacturing realignment costs of $48 million, Japan restructuring costs of $28 million, and spin-off costs of $16 million have been excluded from segment operating income in 2007 when evaluating segment performance. Our segment results are reconciled to total Company results from continuing operations reported under accounting principles generally accepted in the United States of America (otherwise known as GAAP) in Note 13, â€śSegment Information and Concentrations,â€ť of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Report. Starting January 1, 2008, NCR began management of its businesses on a geographic basis, changing from the previous model of global business segments. This change to NCRâ€™s management system and therefore, its segment reporting for 2008 and future periods is further described in Note 14, â€śSubsequent Event,â€ť of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Report.
Financial Self Service provides ATM-related technologies including cash dispensers, services and software solutions to financial institutions, retailers and independent deployers. Our Financial Self Service solutions are designed to quickly and reliably process consumer transactions and incorporate advanced features, such as the automation of cash and check deposits, bill payment, web-enablement and the dispensing of non-cash items.
Our strategy is to fully distribute our sales force and invest in emerging markets such as China, India and Russia. Also, we believe we are well-positioned to take advantage of our market-leading deposit automation technology and software, which allows checks to be digitally scanned upon deposit at the ATM so that financial institutions can eliminate the costly and slow process of clearing the paper form of the check. Additionally, in 2007, we built a more competitive cost structure by realigning our global manufacturing operations.
Financial Self Service revenue increased 15% in 2007 from 2006. Foreign currency fluctuations provided a 4% benefit to the year-over-year revenue comparison. The revenue increase was driven by double-digit revenue growth in both the Europe and Asia/Pacific regions. Operating income increased $35 million compared to 2006. The increase in operating income was primarily due to increased sales volume, partially offset by an adverse geographic revenue mix and targeted investments in sales, demand creation, and research and development activities.
Financial Self Service revenue increased 2% in 2006 from 2005. Foreign currency fluctuations provided a 1% benefit to the year-over-year revenue comparison. Operating income decreased $39 million compared to 2005. The decrease in operating income was primarily due to an adverse geographic revenue mix, price erosion and transition costs associated with our efforts to improve supply chain and manufacturing costs.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
As more fully discussed in later sections of this MD&A, the following were the significant events for the third quarter of 2008:
Revenue growth driven by increases in all regions: Americas; Europe, Middle East and Africa (EMEA) and Asia Pacific and Japan (APJ);
EMEA and APJ regions experienced improved gross margin performance period-over-period; and
NCR continued organizational realignment and business process improvement initiatives and recorded $12 million of realignment costs.
We continued our focus in the quarter on our strategic initiatives to increase operating income and provide maximum value to our stakeholders. The initiatives and the actions we are taking are as follows:
1) Drive profitable growth â€“ We expect to invest in sales and other demand creation resources in areas with the greatest potential for profitable growth, such as self-service technologies, including self check-in/out and other self-service solutions. We continue to broaden the scope of our self-service solutions for our existing customers and to introduce these solutions into newer industry-vertical markets, such as travel and hospitality, healthcare, entertainment and gaming, and public sector. For the first nine months of 2008, we made investments relating to our entertainment and financial solutions portfolios. We continue to expect to make acquisitions and investments that we believe will increase our market coverage and enhance our existing solution offerings.
2) Strengthen competitive position â€“ The Company expects to focus on increasing the efficiency and effectiveness of our core functions and the productivity of our employees. Areas of emphasis are expected to include product development, manufacturing and supply chain, customer services delivery and our overall management system. In 2007, we completed the ATM manufacturing realignment program. As of the end of the first quarter of 2008, the Company had also completed the majority of the activities related to its realignment program in Japan. The Company has been successful in executing these realignment programs, as planned, and is realizing the full program benefits beginning in this year. During the third quarter of 2008, we continued the organizational realignment and business process improvement initiatives that we had started in the second quarter of 2008 to address unbalanced resource allocation and legacy process inefficiencies. Refer to â€śRestructuring and Re-engineeringâ€ť in this MD&A for more information regarding our realignment initiatives.
3) Evolve to a more customer-focused, high-technology culture â€“ We continue to focus on the traits and competencies necessary to enable us to deliver profitable growth and strengthen our competitive position. This will be accomplished through organizational and people development, management system changes and alignment, and a stronger linkage between compensation and performance. On January 1, 2008, NCR began management of its business on a geographic basis, changing from the previous model of global business units organized by product and service offering. The new organizational model is delivering increased sales productivity and is expected to reduce overall operating costs.
We expect to continue with these initiatives for the remainder of 2008 and beyond, as we refine our business model and position the Company for growth and profitability. Unless otherwise noted, this MD&A excludes information related to the Teradata Data Warehousing business, which is classified as a discontinued operation for all periods presented due to its spin-off from the Company on September 30, 2007.
Thanks, [Lori]. Good morning and thank you everyone for joining us for our third quarter 2008 earnings call. Bill Nuti, NCR's Chairman and CEO, will lead our conference call this morning. After Bill's opening remarks, Tony Massetti, NCR's CFO, will provide comments on NCR's total company financial results and our guidance for the full year.
Our discussion today includes forecasts and other information that are considered forward-looking statements. While these statements reflect our current outlook, they are subject to a number of risks and uncertainties that could cause actual results to very materially. These risk factors are described in NCR's periodic filings with the SEC and our annual report to stockholders.
On today's call we will also be discussing certain non-GAAP financial information such as free cash flow and results excluding the impact of pension and other items. Reconciliations of non-GAAP financial results to our reported and forecasted GAAP results, and other information concerning such measures are included in our earnings release and are also available on the Investor page of NCR's website.
A replay of this conference call will be available later today on NCR's website, NCR.com. For those listening to the replay of this call, please keep in mind that the information discussed is as of October 23, 2008 and NCR assumes no obligation to update or revise the information included in this conference call, whether as a result of new information or future results.
With that, I'll now turn the call over to Bill.
Thank you, Gavin. Good morning, everyone, and thank you for joining us.
NCR's strong third quarter results were broad based geographically and reflects continued solid demand for our self-service solutions. NCR has delivered strong results during the first three quarters of 2008 and we are well positioned to continue doing so over the balance of the year by remaining focused on our strategy, which is managing for profitable revenue growth, building a sustainable and leading cost structure, and improving our working capital position.
Several major economies around the world have entered a very challenging period and we'll talk a little bit more about that today. That said, we continue to hear from our customers and prospects that NCR solutions improve productivity, reduce their costs, increase revenues and improve the customer experience. While no one is immune to economic dislocations of recent proportions, NCR solutions have a clear and tangible return on investment. This relative customer sentiment is evident in our business results and our outlook for the balance of the year.
We have maintained our business momentum thus far in 2008 as evidenced by solid execution, strong revenue growth, margin expansion and significantly improved cash flows. On the cash flow front we are extremely pleased with our results in Q3 as we generated $157 million of operating cash and $120 million of free cash flow. We remain focused on our key management priorities, and while we have significant work ahead of us, we continue to demonstrate solid execution and make good progress against our goals.
For the remainder of our comments in the prepared statements, we will be comparing NCR's results from continuing operations versus the prior year. The results for prior periods do not include the impact of Teradata, making this an apples-to-apples comparison.
NCR delivered an outstanding third quarter with year-over-year revenue growth of 8% and an 18% increase in non-GAAP income from operations. We achieved revenue growth in each of our three geographic segments and 30 basis points of gross margin expansion in aggregate. Our results by segment in the third quarter were as follows:
Revenues in the Americas grew 9% to $620 million. We were generally pleased with our results in the Americas, which were driven primarily by the increase in sales to financial institutions.
Revenue from EMEA was up 4% to $502 million, with an approximate 3 point benefit from foreign currency. EMEA's results were driven by strong performance in the banking sector in emerging markets.
And revenue from Asia-Pacific/Japan was $257 million, up 14% from Q3 2007, which included an approximate 5 point benefit from foreign currency. Our growth in APJ was driven primarily by strong demand for our products and services in China and Japan.
In dollar terms, the majority of our growth in the quarter came from our banking customers. We also had better-than-expected results in retail, which was particularly impressive given a difficult compare and a competitive peer group that has recently reported negative growth.
In banking, growth continues to be driven by emerging market expansion, market share gains in most key markets, and the success of deposit automation. We're seeing solid demand for our ATM kiosk solutions both in the United States and internationally. In the United States we expect Check 21 rollouts and our new innovative NCR self-serve family of ATM kiosks to continue to be our growth drivers. Among the financial services industry highlights from Q3 were the following:
We continued to ramp up the deployment of our new self-serve multi-check solution for ATM deposit automation at several leading U.S. financial institutions, including J.P. Morgan Chase and several key financial institutions in Europe, the Middle East and Asia.
The rollout of NCR's self-serve continues to progress successfully, with over 8,000 units ordered by more than 230 customers around the globe year-to-date. NCR's self-serve has already been installed by major customers in both developed and emerging markets. Customer reception for our new product line has been extremely positive, and we have completed our series of international product road shows in South America with impressive events in Argentina, Brazil, Chile and Colombia, touching more than 500 customers across that region.
Also in the quarter we announced the acquisition of NCI Limited, a U.K.-based company that is the leading provider of teller connectivity software used by retail banking institutions to realize the benefits of branch automation solutions throughout their retail environment.
NCI's applications are widely used by retail banks in North America and Europe as they seek to innovate branch automation solutions that improve productivity, simplify the cash handling process, and reduce wait times for customers. This acquisition will make it easier for NCR and our banking customers around the world to introduce and integrate branch automation technologies that can transform branch productivity and the customer experience.
And in China NCR continues to lead the ATM market in 2008, securing significant wins with the top five local Chinese banks - Industrial and Commercial Bank of China, Bank of China, China Construction Bank, Agricultural Bank of China, and Bank of Communications, totaling approximately 6,000 units ordered. We are pleased that NCR continues to gain the largest order share in the market, which continues to reinforce our leadership position in the Chinese market.
Apart from the top five major banks, we also achieved positive results from small and medium-sized commercial banks. According to the latest Retail Banking Research Global ATM Market and Forecast to 2013 report, NCR is confirmed as having the largest ATM installed base in China as of year end 2007. With the total unit orders from China's major and nationwide banks in 2008, NCR continues to maintain its leadership position in China. RBR forecasts the China ATM market will continue to maintain double-digit from 2008 to 2013.
This same RBR report, released in August of 2008, shows NCR with 30.1% of the global ATM installed base, which is over 40% larger than our nearest competitor. And in the U.S., which remains the largest single ATM market in the world, NCR for the first time attained the leadership position in shipments of ATMs to banks according to ESP Consulting, a firm that specializes in research on the U.S. market.
We also experienced solid results in the retail industry, driven primarily by our new innovative point of sale solutions. Even in tough times, retailers continue to invest in NCR's solutions because they significantly increase front end productivity, reduce cost and improve the customer experience.
There were several highlights in the retail space as the third quarter marked another significant milestone for our industry leading self-checkout solution, NCR Fast Lane. In partnership with a major European retailer, we installed our new Release 5 unit, our latest and most innovative self-checkout offering to date.
For the first time, retailers will have the convenience of note and coin recycling, designed to improve availability and reduce cash management costs. Release 5 also features our patented two-sided thermal printing as an every unit item, reducing paper consumption and enabling advanced marketing capabilities. Release 5 is the most compact solution available on the market. Drug stores, convenience stores and other space-constrained retailers globally can now offer the choice and convenience of self-checkout to their customers.
On the new product front, NCR also announced the launch of our latest point of sale workstation, the RealPOS 70XRT. This solution is designed to deliver the next generation of CPU innovation, dual core processors, DDR2 memory, SATA disk drives, integrated rate support, gigabyte Ethernet, and Intel Active Management Technology, with the result being advanced performance and functionality, an innovative design, and industry leading service ability and manageability. Retailers around the globe in hospitality and convenience industries, as well as other retail industries, are prospects for this new platform.
The NCR 70 XRT is a compact terminal that leverages the same core technology as our market winning RealPOS 80XRT. Combining Intel's next generation, low-power processor and chipset architecture with a high efficiency power supply, the NCR RealPOS 70XRT can reduce energy consumption by up to 50% over previous generation point of sale terminals. The RealPOS 70XRT is built with an innovative easy glide blade system that allows for tool-free access to internal components, improving system availability and reducing support costs.
In Japan, NCR RealGate Payment, our point of sale application for payments, was the first to complete VISA's payment application best practices validation, which supports NCR's strategy of strengthening our solution portfolio in core industries in Japan.
In the services arena, Carrefour Argentina - that country's largest retailer - selected NCR to provide comprehensive managed services support. Under a three-year agreement, NCR will be Carrefour Argentina's primary technology provider, providing hardware and software help desk services for almost 200 sites, including branches, platforms and administrative offices throughout the country. A total of 16,000 workstations and 63 applications are covered by this agreement.
In China, NCR won a major order totaling 2,500 NCR RealPOS 21 point of sale terminals from Dico's Fried Chicken, China's top Western fast food franchise operation. In addition to the hardware platform, NCR will provide Dico's with post-sale maintenance and support services. The deployment of these new terminals will help Dico's meet the growing expansion of its franchise stores nationwide and expands upon the company's initial order for 500 NCR RealPOS terminals in 2006.
In their most recent financial analysts call, leading U.K. food retailer Tesco referenced the critical importance of self-service technology to their business. They mentioned that they were experiencing improved self-service levels in their stores with the statement that self-checkout systems are very popular with their customers and now account for 20% of all in-store transactions.
Tesco is a prime example of a retailer that recognizes how self service is critical to achieving their business goals. They are innovating the next generation of the front end experience now and getting tremendous business benefits as a result. They understand that over the next 5 to 10 years the retail front end will be completely transformed by self service, lowering operating costs, improving store throughput and productivity, and improving the customer experience.
In addition, we remain encouraged with the overall revenue trends in our emerging industries, which we identify as travel and hospitality, health care, gaming and entertainment, and government and public sector. The combination of productivity gains, cost reduction and increased consumer demand for self service channels are fueling our opportunity to become the global leader in providing solutions to meet this demand. Although we are still looking at small revenue compares in our emerging industries relative to our established banking and retail industries, we see great opportunities ahead.
In the quarter, NCR extended its self service portfolio further into the entertainment market by taking several important steps. We are capitalizing on several opportunities in the growing entertainment market in the U.S. and other major countries. Our goal is to become the market leader in this industry and our product lineup, which includes Touch Automation, ePlay and Ambient, provides us a platform to lead in this industry.
And we continued to build on that position in the third quarter. NCR and Blockbuster Entertainment entered into an agreement to deploy Blockbuster-branded state of the art DVD vending kiosks in a pilot program that could be the first step of a nationwide rollout of thousands of units. The initial deployment of 50 Blockbuster-branded kiosks will begin in the fourth quarter and all units are expected to be installed by Q1. The pilot digital media kiosks will initially offer DVD rentals, but also allow for future applications, including digital download and other services, such as sales of DVDs and video games.
NCR and Toshiba agreed to enter into an equity investment in Mod Systems, an industry leading provider of digital media delivery systems. The investment is part of an ambitious initiative to leverage the breakthrough portable digital storage technology that offers the potential to revolutionize how consumers download movies, TV shows, music and other digital content at a wide variety of locations, then replay it on multiple devices. The initiative will combine technologies developed by each of the companies involved and is aimed at meeting the explosive demand for portability, easier access to high quality visual entertainment and other content.
In the health care space, NCR extended our self service portfolio into the international market with the introduction of our China-customized patient registration and payment solution, MediKiosk, at the 12th China Hospital Information Network's conference. By building on the foundation of NCR's world-leading health care solutions, this customized suite is specifically designed to meet the unique requirements of China's health care industry.
The NCR MediKiosk solution connects to the hospital information system of China's health care institutions and allows patients to register, pay bills and print invoices. The customized solution provides tools to help hospitals streamline workflow, reduce management costs, improve service quality and enhance the overall patient experience.
Whether it's growing these emerging industries or furthering our market leadership in established product solutions like ATMs or self-checkout, we cannot make the most of our many opportunities if we don't execute on our planned operational improvements. In the quarter we continued to make progress towards building a sustainable leading cost structure, a cost structure characterized as industry's best practice, providing both a competitive advantage and financial flexibility.
As part of that commitment, we continued with initiatives to further increase our productivity, make us more responsive, and to position NCR as a company that is simpler to do business with. These actions will also contribute to making NCR more customer focused and market driven.
As we communicated to your during our analyst day presentation last December, we have targeted approximately $150 to $200 million in cost saves in the three-year period 2008 to 2010, of which approximately half would drop to the bottom line and the other half will be reinvested into the business. Our new industry focused structure has provided significant opportunity to provide or improve both our business processes and, most importantly, our ability to better serve our customers.
And we continue to make progress in the third quarter, specifically in the areas of reverse auctions, low-cost region sourcing and logistics optimization. Increased participation from new vendors in reverse auctions and a mix shift from repeat to new auctions have driven savings, and we continue to shed the past legacy of single source suppliers, which has allowed us to generate more competition across lower-cost regions' bidders, countries like India and China.
Also in Q3, we continued moving spend from higher-cost regions to lower-cost regions and localizing the spend with lower-cost suppliers. The redesign of our supply base continues to build flexibility and cost advantages into our supply chain. And we're optimizing our logistics and materials management processes. We continue to consolidate warehouses to reduce cycle times and waste, and we're restructured our materials management to reduce waste and lean the process by co-locating warehouses with factory locations where relevant.
Our cost reduction value engineering teams are focused on a variety of initiatives that will lower cost and drive higher quality. We will continue to focus on creating efficiencies throughout the organization and by doing so expect to achieve our margin objectives over the next three years.
Now I'll turn the call over to Tony, who will discuss our financial results in greater detail. Tony?
NCR's total revenue from continuing operations of $1.38 billion grew 8% versus Q3 2007. This includes a 2 point benefit from currency translation. We reported GAAP income from continuing operations of $82 million or $0.49 per diluted share. This compares with $33 million or $0.18 per share in Q3 2007.
NCR's results from continuing operations did have special items in those quarters. In Q3 2008 there was a $12 million cost - $10 million after tax - related to organizational realignment. And in Q3 2007, NCR's continuing operations had three special items - first, a $24 million after-tax charge for a restructuring initiative in Japan; second, an $11 million after-tax expense for spin off of Teradata; and third, $4 million after-tax cost related to the company's manufacturing realignment. Excluding these items, non-GAAP diluted earnings per share from continuing operations grew 41% to $0.55 per share in Q3 2008 versus $0.39 per share in the prior year.
We had pension expense of $5 million from continuing operations in the quarter compared to $12 million of pension expense from continuing operations in the third quarter of 2007.
To analyze NCR's operational performance without the effect of special items and pension expense, please see the supplemental financial schedule included in our earnings press release that reconciles our GAAP to non-GAAP results. For the remainder of my comments during today's call, I will exclude the impact of the special items and pension expense.
Our Q3 gross margin was 23.5%, up 30 basis points from the 23.2% achieved in the third quarter of 2007, driven primarily by the realization of benefits from our manufacturing realignment and continued emphasis on cost reduction initiatives.
NCR's operating expenses were up 5% or $9 million versus Q3 2007, primarily due to slightly higher SG&A expenses in the quarter. Operating expenses as a percentage of revenue decreased 50 basis points versus the prior year period.
Total company non-GAAP income from operations of $117 million increased 18% from Q3 2007. Non-GAAP operating income was 8.5% of revenue in the quarter, up from 7.7% of revenue in the prior year period.
Below the operating income line, we had $1 million of other expense in Q3 2008 compared to $12 million of other income in the third quarter of last year.
The tax rate in the third quarter was 17.1%. Income tax expense included a $16 million benefit related to routine Internal Revenue Service audit settlements for the years 2000 to 2006. We continue to expect our full year 2008 effective tax rate to be 25%.
Turning to the balance sheet, we ended the quarter with $733 million of cash.
Our short and long-term debt was $308 million.
During the quarter we repurchased approximately 4.1 million shares of our common stock for $104 million. This left approximately $95 million of Board authorization available for future share repurchases as of the beginning of the fourth quarter of 2008. And to give you an update of our share repurchase activity since the close of the third quarter, we have repurchased 3.7 million shares of common stock for $69 million from the start of October through yesterday. This leaves approximately $26 million of Board authorization remaining as of today.
Moving to the cash flow statement, in the third quarter NCR generated $157 million of cash from operating activities versus $65 million in the prior year period. After investing $37 million in capital expenditures, we generated $120 million of free cash flow compared to $40 million of free cash flow in the third quarter of 2007. NCR defines free cash flow as cash from operations less capital expenditures for property, plant and equipment, and additions to capitalized software.
As we mentioned in our Q2 earnings call, we are focused on better management of our accounts receivable and inventory. In the third quarter of 2008 we improved in both areas. During Q3 2008, our accounts receivable balance declined $48 million versus the second quarter, and our inventory balance declined $24 million versus Q2 2008.
We are very pleased with our third quarter operating and financial performance and the solid momentum we are experiencing across the board, although we continue to be somewhat cautious for the balance of the year due to the broader macroeconomic environment and more difficult financial comparisons given NCR's strong performance in the fourth quarter of 2007.
That being said, based on our strong results here to date and our current outlook for the fourth quarter, we are increasing our full year guidance as follows:
We now expect full year revenue growth of 8% to 9%, up from the previous guidance range of 6% to 8% growth. We are increasing our non-GAAP earnings guidance to a range of $1.67 to $1.72 per diluted share, up from the previous guidance range of $1.62 to $1.67 per diluted share. We forecast pension expense of $25 to $30 million in 2008. Our full year tax rate is expected to be approximately 25%. And we also expect free cash flow to be $225 to $250 million in 2008, excluding the cash payments associated with our operational realignment activities.
Now I'd like to turn the call back over to Bill for some closing comments.
Thank you, Tony.
Overall, I'd give us a good grade on the first three quarters of 2008. Revenue growth, margin improvement, earnings and cash flow have been strong, and we are optimizing the use of our capital structure to improve shareholder value. Moreover, we remain focused on operating the company more efficiently, both for today and tomorrow.
That we're achieving these results in light of the significant macroeconomic concerns makes them that much more noteworthy. And as Tony just mentioned, we raised our outlook for the full year 2008. So I would like to add a little perspective to why we're feeling good about how NCR is executing and the momentum we're building in terms of our product offerings and go to market strategy.
Obviously our core solutions are sold into two industries - banking and retail - that are under pressure not only at home but abroad. But as our results indicate and our guidance indicates, demand has remained relatively healthy. Speaking to ATMs in particular, we believe the current consolidation in the financial services industry helps to underscore the need for products and services that attract and secure depositors and at the same time help banks more efficiently manage their interactions with customers.
We are in a banking environment that is placing an aggressive renewed focus on attracting depositors. ATM technology for most banks plays a key role in customer acquisition and retention. Also, it's important to understand the strategies of various banks with regard to progressing towards intelligent deposit replacements. Generally speaking, banks whose consumer strategies have been more reliant on lending are the ones being subsumed now. NCR's installed base with large acquirers like J.P. Morgan Chase and B of A are strong, and these are the very banks who have embraced intelligent deposit migration.
So while we keep a close eye on spending in this environment, we feel good about our position with large U.S. banks that are emerging as the survivors and acquirers. And we're also feeling good about the investments we've made in new technologies to support the advanced capabilities that these intelligent deposit leaders of the world are looking for. While the longer-term net effect of bank consolidation might impact the ATM installed base, the near-term impact is difficult to outlook and may well turn out positive. A faster upgrade to intelligent deposit ATMs by large U.S. banks is an example.
Internationally, we still envision growth to be driven by penetration into emerging markets in Asia, the Middle East and Eastern Europe.
We enjoy a strong position with the leading financial institutions in North America and throughout the world as evidenced by the RBR and ESP reports I referenced earlier. This position maintain in the midst of a difficult period for the financial services industry is supported by the technologies and capabilities we're bringing to market.
I've said often this year that NCR is in perhaps the most innovative period in our almost 125 years. We've talked recently about our new ATM platform, self serve; our kiosk innovations for multiple new verticals that NCR has never reached before; our new self-checkout platform, Release 5; our two-sided thermal paper that saves customer's money and has a positive environmental impact, and there are many, many more.
As we extend the reach of our solutions into other verticals in the growing self-service space, we are adding another element to our platform, a new global brand for the new NCR, which will define our company and our vision, leading how the world connects, interacts and transacts with business. NCR is at the center of the self-service revolution, strategically poised between contemporary consumers who demand fast, easy and convenient options and businesses focused on increasing revenues, building customer loyalty, and lowering their cost of operations.
Our leadership in customer interactions is anchored in our deep understanding of consumers and our domain expertise in the industries we serve. NCR is the only company focused beyond a niche self-service technology, geography or market, and our brand will reflect that.
We look forward to sharing more with our customers and our shareholders about the launch of our brand later this year at the upcoming BAI retail conference in November and our analysts' day on December 4 in New York City, but it's not about marketing. NCR remains sharply focused on executing and operationalizing our business strategy, delivering profitable market and wallet share gains in our traditional industries and breakthrough growth in new industries, remaining focused on building a sustainable leading cost structure and evolving to a more externally focused culture that is customer, market, competition and consumer driven.
These priorities take on even more importance in uncertain times, but the current climate does not alter the conviction we all share in our longer-term vision and opportunity to deliver great value to our customers, employees and shareholders.