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Teradata Corporation (NYSE:TDC)

Q2 2010 Earnings Call

August 5, 2010 08:34 am

Executives

Gregg Swearingen - Investor Relations

Mike Koehler - Chief Executive Officer

Steve Scheppmann - Chief Financial Officer

Darryl McDonald- Executive VP of Business Development and Marketing

Analysts

Wamsi Mohan - Bank of America

Katy Huberty - Morgan Stanley

Matt Summerville - Keybanc Capital Markets

Mark Kelleher - Brigantine Advisors

Alex Kurtz - Merriman & Company

Nabil Elsheshai - Pacific Crest Securities

Brad Reback - Oppenheimer

Derrick Wood - Wedbush Securities

Greg Halter - Great Lakes Review

Operator

Welcome to the Second Quarter 2010 Teradata Earnings Conference Call. My name is Sandra and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. Please note that this conference is being recorded.

I’ll now turn the call over to Mr. Gregg Swearingen. Mr. Swearingen, you may begin.

Gregg Swearingen

Good morning, and thanks for joining us for our 2010 second quarter earnings call. Mike Koehler, Teradata’s CEO, will begin our discussion summarizing Teradata’s second quarter results. Steve Scheppmann, Teradata’s Chief Financial Officer, will then provide more details related to our financial performance, as well as our updated 2010 guidance. Darryl McDonald, Teradata’s Executive VP of Business Development and Marketing, is also in the room to answer questions.

Our discussion today includes forecasts and other information that are considered forward-looking statements. While these statements reflect our current outlook, they are subject to a number of risks and uncertainties that could cause actual results to vary materially. These risk factors are described in Teradata’s 10-K and other filings with the SEC.

On today’s call, we’ll also be discussing certain non-GAAP financial information, such as earnings per share, excluding stock-based compensation expense, free cash flow and revenue comparisons in constant currency. A reconciliation of our non-GAAP results to our reported GAAP results and other information concerning these measures is included in our earnings release and on the investor page of Teradata’s website at teradata.com.

A replay of this conference call will also be available later today on our website. Teradata assumes no obligation to update or revise the information included in this conference call whether as a result of new information or future results.

I’ll now turn the call over to Mike.

Mike Koehler

Thanks, Gregg. Good morning, everyone. Teradata had its best second quarter ever reporting revenues of $470 million, up 12% from Q2 of 2009 and operating income of $106 million, up 26% over the last year. Operating income, operating margin and gross margin rates were the highest of any quarter in Teradata’s history.

Our platform family appliances had a strong second quarter and are now installed in over 125 customers in 20 countries. This has been accomplished in a very short timeframe of approximately two years since they were launched. Our investments in the platform family, along with our investments in new territories and focus on new account acquisitions, are going well. New customer wins for the first half of 2010 was our strongest performance in the last five years. These were also key contributors to our revenue growth for the first half, which was up 12%, and product revenue, which was up 22% in constant currency.

Some highlights on a region perspective, the Americas delivered an excellent Q2 generating $281 million of revenue, up 23% from the second quarter of 2009 and product revenue up 42%. For the first half, revenue growth in the Americas was 23% with product revenue up 40% over prior year. The Americas had a strong quarter for new account wins, which included Frito-Lay where a Teradata enterprise data warehouse is replacing a competitor. Manufacturers like Frito-Lay will utilize geospatial location data to improve real-time distribution of their products.

W.W. Grainger, a Fortune 500 distribution company, will use Teradata to help analyze and improve overall customer relationships and customer value. Our ongoing partnership with SAP helped in this new customer win. Oklahoma Gas & Electric which is a new data warehouse appliance customer in the utility industry and one of our growth markets. We’ve had good activity with utilities as y look to improve operations today and prepare to leverage the large real-time data from smart meters actionable information.

Serasa Experian the Brazilian part of the world’s largest credit bureaus will rely up on the speed and scalability of Teradata to analyze massive volumes of data and develop new products.

The Americas also added another top five pharmaceutical company in the quarter and added one of the largest financial institutions in the world where we also replaced a competitor's data warehouse.

Other new customer wins with data warehouse appliances included Bank of New York Mellon, Aviva Canada and Skechers footwear where we are replacing a competitor system to improve the company’s wholesale business.

While the Americas had a great quarter for new customers they also saw broad-based growth with current customers in the quarter including AT&T, one of several customers who are members of our petabyte club, which are customers who have EDWs with over a petabyte of data. AT&T is enhancing its Teradata system to support 360 degree view of its customers for improved marketing, advertising and sales operations.

At eBay we announced during Q2 our collaboration to develop analytic competencies for better customer online experiences. Starting with a six petabyte Teradata appliance, eBay is analyzing 30 terabytes of customer interaction data each day. This is in addition to eBay’s purpose built or private cloud ETW implementation, which put them in Teradata’s petabyte club several years ago. This is a good example of customers leveraging different members of our platform family for different analytical needs.

We also saw expansions and upgrades at World Bank Financial Group, Verizon, Delta Airlines, JC Penny, TIM Brazil where partnered with SAS[ph] and at Chrysler, which added a data warehouse appliance. In summary, Q2 was an outstanding quarter for the Americas as was as Q1.

In the EMEA region, Q2 revenues of 108 million was down 8% as reported and down 3% in constant currency. For the first half, revenue was flat as reported and also flat in constant currency. EMEA was going against a first half prior year comparable when revenues grew 9% in constant currency. EMEA had a good quarter for new customer wins. Some highlights included BNP Paribas in Belgium, which is installing Teradata to enhance such customer relationship management capabilities. Analytics Private Limited in Pakistan will use a Teradata data warehouse appliance as the platform for their software and service cloud offering.

The Royal Mail in the UK, which joins a growing number of the EMEA postal and package delivery customers, including DHL, the Czech Post, Poste Italiane and GNT to name a few.

Maersk, one of the leading liner shipping companies in the world, was also one in the quarter and will be using Teradata to compliment its SAP environment to integrate SAP and non-SAP data. The Teradata EDW will play a major role in their transformation to an analytics driven company.

Also with the win at a major telco in Europe, Teradata has now installed in all of the global top 20 telcos in the world. We also continue to see good activity from existing EMEA customers. As they continue to increase the size and scope of their Teradata platforms, including Air France, which is expanding their EDW to address more sales and marketing applications. C&A, a retailer that is expanding their Teradata EDW tripling data volume adding 10 times to users and strengthening active warehouse elements including improved workload management.

Bank Söhne in Poland added a data warehouse appliance to their existing EDW. Other customer expansions included at Barclays, Jaguar Land Rover, Vodafone, and the Commercial International Bank in Egypt.

Turning to Asia Pacific/Japan, we’ve reported $81 million of revenue in the second quarter, up 9% from Q2 of 2009 and up 4% in constant currency. For the first half, revenues were up 9% as reported and up 1% in constant currency. Several new customer wins in the quarter came from the financial services industry including the Bank of Okinawa, which will use their Teradata system for revenue management and improve transfer pricing. Guangzhou Bank in China, which bough a data warehouse appliance and our financial services logical data model for its entry level EDW, GS Securities, a large Chinese stock brokerage firm.

APJ upgrades included Vodafone New Zealand, which is adding analysis of geospatial location data for improved marketing and network analytics, and Oita Bank in Japan, which is enhancing their business intelligence capabilities with Teradata and SAS. In addition, SAS Marketing Automation software will run on Teradata to improve customer segmentation and drive more effective marketing campaigns.

Other upgrades and expansions included the Commonwealth Bank of Australia, the Australian Customs and Border Protection Services, Toshiba, Chi Mei Optoelectronics, Fuji Xerox, The Bank of East Asia, Resona Bank, APL in Singapore, and Murata Manufacturing in Japan which added a data warehouse appliance.

As mentioned earlier, we are pleased with the results of our purpose built platform family and the return we're seeing our R&D investments there. Our competitive win rates and product margins remain strong across all members of the platform family. Our strategy to enter the appliance market is proving to be successful, helping to attract new customers and helping to expand share with current customers.

Over 10% of our product revenues came from data warehouse appliances in Q2, and close to 10% of our product revenues in the first half of 2010. We continue to expect our appliances to contribute 5% to 10% of our product revenues going forward.

Our Active EDW platform results were also excellent for the first half and will continue to be key contributor to our business. We will continue to invest and focus on leading the market for the most demanding active data warehouse environments in the world.

We're also seeing momentum with Teradata's analytical applications. In the enterprise marketing management space, our Teradata Relationship Manager solution has seen good success this year. CVS Caremark, the (inaudible) Bank and Telefonica are just a few customers driving revenue growth using Teradata to quickly capitalize on every customer interaction. Teradata Relationship Manager was also recognized by Gartner. Again, being positioned in the leader squadron for multi-channel, campaign management.

In Q2, we also announced enhancements to our demand chain management solution. One financial analyst recently noted that the Home Depot is implementing Teradata’s demand chain management system and has already improved the accuracy of demand forecasting by 15% to 30%, which is a material improvement for a retailer.

In summary, our revenue growth in the quarter, and for the first half, are evidence that we are beginning a return on our investments in R&D, partners and sales territory. Looking forward given our first half performance, we now expect our revenue growth and earnings per share for the full year to be at the high end of our previous guidance ranges.

With that I will now turn the call over to Steve Scheppmann to discuss our Q2 results and our full year outlook in more detail. Steve?

Stephen Scheppmann

Good morning. Our solid Q2 results validated comments we made at beginning of the year that we expected a strong first half of the year particularly in the Americas. Revenue of $470 million was up 12% from the second quarter 2009 and also up 12% in constant currency. Revenue for the first half of the year was up 14% and 12% in constant currency. Product revenue up $223 million was up 21% from the second quarter of 2009 and up 24% for the first half. Services revenue up 247 million was up 5% and 7% year-to-date. Within services consulting services was up 4% in Q2 and maintenance services was up 6%.

Gross margin in the second quarter was 57% compared to 55.3% in the second quarter of 2009. Higher product gross margin offset lower services gross margin in the quarter. Product gross margin of 68.2% increased from 64.3% in Q2 2009. The increase was primarily driven by positive deal mix. Product gross margins increased in all three regions. Services margin of 47% as anticipated was lower than the strong services gross margin achieved in Q2 2009 due to, as we've had previously referenced, building capacity to grow revenues.

On the positive front, demand for our consulting business has increased, and we are adding more value creation resources to meet this demand. While these new resources are added, trained and working[ph] they become more fully productive and profitable, we anticipate that this will lower our services gross margins from the levels achieved in 2009 when we were not adding resources and related costs.

Moving to a geographical view of gross margin. In the Americas region, gross margin was 60.9%, an improvement from 58.1% in the second quarter of 2009, driven primarily by higher product margins as well as a higher proportion of product revenue compared to the services revenue.

Gross margin in the EMEA region of 52.8% was down from the 54.2% reported in the second quarter of 2009, driven by a lower proportion of product revenue as compared to services revenue as well as lower consulting services margins.

Gross margin in the APJ was 49.4%, up from 48.6% in Q2 2009. The increase was driven primarily by higher product and maintenance margins as well as a greater proportion of product revenue as compared to services revenue.

Turning to our expense structure. SG&A expense in Q2 2010 increased $4 million from the year ago period. The increase was largely driven by increased selling expense. However, when looking at SG&A as a percentage of revenue, we continue to improve the efficiency of the SG&A investment year-over-year. Even coming off of a tight austerity year 2009, where specific cost reductions and deferral programs fluctuated quarter by quarter as we actively managed expenses. SG&A expenses in 2010 will return to a more normalized level, more comparable to the 2008 levels but an improved percentage of revenue versus the 2009 SG&A revenue efficiency rate, even while continuing to execute our strategic initiative of expanding our sales territories.

The continued improvement in leveraging the efficiency of our SG&A infrastructure is one of the strategic drivers of our long-term operating margin expansion. R&D in the quarter was $36 million versus $27 million in the second quarter of 2009. As anticipated, we continue to invest in our core database platform family consistent with our post spend strategy. For the full year 2010, we now expect R&D to increase in the mid 20s percentile year-over-year.

As a result of all of these items discussed, Teradata's operating margin in the second quarter was a record 22.6% versus 20% reported in Q2 2009. For the full year 2010, we expect operating margin to be in the higher end of the 19% to 20% range we had previously discussed. However, increased investments in sales and R&D will create more of a headwind from margin and EPS, specifically in Q3 and Q4.

Below the operating income line, the effective income tax rate in the second quarter of 2010 was 30%, which compared to 26% tax rate in the prior period, driven by an overall proportional increase in US pretax earnings. Due to the expectation that a higher proportion of Teradata's pretax income will be generated in the United States and the uncertainties surrounding the retroactive restatement in 2010 of the US Federal Research and Development Tax Credit, we anticipate a potentially higher full year effective tax credit for 2010 in the 27% to 28% range.

As a result, GAAP EPS in Q2 2010 was $0.44 versus $0.36 in Q2 2009. Non-cash stock-based compensation expense is included in our operating and EPS results. During the quarter, stock-based compensation expense was approximately $6 million or $0.02 per share.

To allow you to better compare our results to those of our other sophomore companies that excludes stock-based compensation expense, we're now providing the non-GAAP measure. Non-GAAP EPS for the second quarter excluding stock-based compensation expense was $0.46. This compares to $0.38 in the second quarter of 2009. For the full year, we expect approximately the same amount of stock-based compensation expense in 2010 as we had in 2009, roughly $23 million or approximately $0.09 per share for the full year.

As a reminder, we have a table on the foot notes of our earnings release as well as detailed schedules on our website that reconciles the differences between our GAAP and non-GAAP results. We will also provide the non-GAAP EPS excluding stock-based compensation expense for the prior periods on our website. For the most part, stock-based compensation expense had a $0.02 per impact on reported quarterly earnings. As an example, it was $0.08 for the full year 2009 approximately $0.02 per quarter.

Turning to cash flow, cash from operating activities was $62 million in Q2 2010 versus the $103 million generated in the second quarter of 2009. When comparing to the prior year the decrease in cash provided by operating activities was principally due to anticipated increase in accounts receivable DSO.

After $23 million of capital expenditures versus $20 million of CapEx in the second quarter of 2009, we generated $39 million of free cash flow down from the $83 million of free cash flow in Q2 2009. During the last few years, we along with many other companies were able to successfully decrease our working capital as we reduced our accounts receivable DSO, which benefited our free cash flow. As you know, as we have discussed over the last several quarters, you can only reduce receivables so much so the larger opportunities increase cash flow from working capital management is for the most part behind us.

In Q2, the meaningful revenue growth that we generated and the timing as such revenue growth added to our receivables balance and increased our working capital needs as one would expect.

Our annual free cash flow generation should return to more normalize levels in line with plus or minus $25 million of net income metric we've talked about since this summer[ph]. Teradata defines free cash flow as cash flow from operating activities less capital expenditures for property and equipment an additions to capitalized software.

Turning to the balance sheet. As of June 30, 2010, we had several $724 million of cash, a $12 million increase from the end of the first quarter 2010. During the second quarter, we did not repurchase any shares of our stock, however, on our year-to-date basis we only purchase $71 million in 2010 compared to $50 million in 2009.

As we said before, we expect that the rate of our buyback will continue to fluctuate each quarter taking into account, among other things, our working capital needs, our stock price, potential alternative uses of cash such as acquisitions, and economic and market conditions.

At the end of Q2, approximately 67% of our cash was held outside the United States and in effect was not available for share repurchases. Almost we repatriate the cash back to the US and pay corresponding taxes as significant tax cost.

We continuously evaluate different options relating to our most efficient capital structure given the current and future factors that may influence our business model in the markets we operate in. With respect to our accounts receivable, DSO was 76 days as of June 30, 2010, compared to 73 days as at June 30, 2009.

To provide further transparency around currency movement, we provided on our website additional detail regarding how currencies moved in Q2 2010 and how this movement is expected to impact our year-over-year revenue comparisons for the remainder of 2010, assuming the currency exchange rates as of the end of July.

As I mentioned earlier, our Q2 total company year-over-year revenue comparison was not impacted by currency translation. EMEA region did see 5 points of currency headwind in the year-over –year revenue comparison in the quarter. However, during the course of the second quarter, currency translations clearly moved against us versus the spot rates at the beginning of the quarter, which cost us approximately $5 million of reported revenue or approximately $0.01 of EPS. As you know, currencies had moved in a more favorable direction since the end of Q2. As result we now expect less than 1% currency benefit impact for the full year revenue comparison, but one to two points of headwind from currency in the third and fourth quarters.

As Mike said earlier in the call, we now expect our revenue and EPS for full year 2010 to be at the high end of our previous guidance ranges, a revenue growth at 8% to 10% and EPS in the range of $1.60 to $1.70. Excluding stock base compensation non-GAAP EPS was expected to be in the high end of the $1.69 to $1.79 range. As we discussed with you last quarter and as we’ve seen in Q2, we expect some of our cost and expense lines to grow faster than normal in 2010 due to increased investments in sales coverage and R&D and our other expense reductions that we saw in 2009 that are partially or fully reinstated in 2010. As a result, we expect our EPS growth was second half of the year and especially in the third quarter to be less than our long-term targeted growing EPS at twice our revenue growth.

Specifically, as we’ve discussed before in Q3 and in Q4 we anticipate headwind from the following. R&D increasing mid 20s percentile or in the 2009 level of $117 million, annualized higher selling expense due to more sales territories and higher commissions and training costs. Normal increases in G&A such as base compensation increases and return of the expenses that were eliminated or reduced in 2009 including training and education. Lower services gross margins as we add to our consulting teams. Finally, potentially higher incentive compensation expense as the company is performing better relative to key incentive plan metrics compared to 2009.

That said, however, we are very pleased with our first half performance and feel very good about our technological and competitive leadership position, which position us well to deliver on our plan guidance for the second half of 2010.

With that, operator, we are ready to take questions.

Question-and-Answer Session

Operator

Thank you, we will now begin the question and answer session. (Operator instructions). The first question is from Wamsi Mohan from Bank of America. Please go ahead.

Wamsi Mohan - Bank of America

Mike, can you talk a little bit about the revenue dynamics in EMEA by region you were down 2% on constant currency despite an easy compare last year, but you had a very tough compare two years ago. So, what sort of growth you expect from EMEA on a constant currency basis in the back half, and if you can share sort of exact numbers even qualitative commentary will be helpful?

Mike Koehler

Regarding EMEA, Wamsi, when we enter the year we had our sights set on the first half to get to a revenue result that was flat in constant currency, which the EMEA team executed to. The pervious year EMEA had grown 9% in constant currency and was going against that type of prior year comparable. Given the recent uncertainties there in EMEA we were looking to get out the first half with flat constant currency in terms of revenue. So, we’re pretty pleased with that result.

Now that we’re into the second half of the year and in particular as we look out to the fourth quarter we expect EMEA to come back quite a bit. When we look at it for the second half of the year and a lot of it's in the fourth quarter we’re looking at mid-to-high single-digits constant currency growth for the second half.

Wamsi Mohan - Bank of America

Okay, thank you. That’s helpful. Steve, you’ve mentioned increased investments and sales resources in Q3 and Q4. Can you talk about why you’re driving these incremental investments now? I mean do you have an updated number of incremental sales territories relative to the 90 territories you had talked about previously? Also can you give us an update on what your plan as relative to the original 100 million targeted you had laid out?

Steve Scheppmann

Yeah, Wamsi. With respect to sales territories, we’re still on target to exit the year with the incremental 90 new sales territories. As you familiar, we had 40 in 2008, 20 in 2009 and looking at that same ramp up 30 in 2010. So, we’re still on target for that.

The operating expenses with respect to increment year-over-year, you’ll see that we had $12 million of increase in the SG&A line. In the first half, we’re looking at increased costs in the second half driven by the new territories, proof of concepts, the incentive comp that I refer to you, customer events and training that when you look year-over-year and even sequentially those are the additional costs coming in.

With respect to on the revenue side, if you remember our conversations, I would say a little less in the year ago, I thought we might be in 2010 about 50% of that $100 million commitment for 2010 for the new territories. We are somewhere, again I said, we’re kind of at the midpoint. My last conversations we’re at kind of the 75% of that targeted number. I still feel comfortable on the 75% to 80% to that targeted number of $100 million.

Wamsi Mohan - Bank of America

Okay, thanks Steven. Last question from me, Mike if I could. You mentioned geospatial a few times on the call, we’ve seen some press sighting RFID getting it opted at Wal-Mart. Can you talk about how we should think about these sort of opportunities, geospatial and RFID in particular? Thank you.

Mike Koehler

Geospatial and location data gives a new data dimension to analytics. So, on top of it generating more data, which is a good thing for Teradata, it gives additional analytical dimensions to new questions companies can ask about their business. So, more usage, more information, more ROI, and value for our customers. The third dimension of it lends itself to real-time type of decision making. So, with geospatial and location data, marketing offers can be made to people at a point based on location and where they’re at in what city. In the case of companies and distribution or retailers and so forth decisions in routing and everything else can be made based on precise up to the minute location of product.

Darryl McDonald

Excuse me this is Darryl McDonald. The other color I would add is that it's an opportunity. As you can imagine people that were doing geospatial work in the enterprise today were really doing it on a specialized server in software with our new enhancements we put in the Teradata 13 and as planned for Teradata 14. Also with our partnerships like we announce this past with week with ESRI, were going to be able to actually load as applications in the Teradata and take the advantage of the power of Teradata, and then as Mike said apply it not only in planning and strategic and analytics but in real time analytics to understand what’s happening now and what’s happening that could be related to market conditions, weather conditions things like that. So, we look forward to be a growing data type that will start to see our user base and prospects that to bring into Teradata.

Operator

Thank you. The next question is from Katy Huberty from Morgan Stanley. Please go ahead.

Katy Huberty - Morgan Stanley

As it relates to the strength in Americas, would you characterize that as a function of improved win rates or do you think the market stronger than we all saw it coming into the end of the year? If it is win rates could you think you improved competitively again?

Mike Koehler

In the Americas and in particularly in the US, there we are benefactor from some projects that has been delayed for the past couple of years and some pent up demand, but in there is an underlying more sustainable thing that’s going on where we do have improved win rates. The other thing is the new account acquisition has picked up and we are gaining more share of higher share of new customers, as well as bringing in new types of applications to apply in the Americas.

The platform family, which I alluded to earlier in our prepared remarks, had a nice second quarter and for the first half was close the 10% of our product revenues and we are seeing a lot of utilization of that when you look at existing customers and new customer acquisition in the US.

So, there is some underlying things here when you are look at a new territories which go hand in hand with the upticks and new customer winds in the US along with the more utilizations of our appliances, all these things are contributing to the strong performance in the Americas in the first half.

Katy Huberty - Morgan Stanley

Is that a particular competitor that you think your win rates have improved against?

Mike Koehler

Our win rates are generally up a little from high levels across the board.

Katy Huberty - Morgan Stanley

If the new customer pipeline has improved is that suggest the Americas gross margin is sustainable in the high 50s if not 50% range, Steve?

Steve Scheppmann

I mean we’ve had the margin dynamics on the appliances are very consistent. That continued to show in Q2. so, Katy I would stay probably with the consistency being on the margins versus any improvement on, because again the dynamics percentage bases are very similar.

Mike Koehler

Katie, I was just going to add, our product margins tend to be lumpy. We just had a good quarter and typically it's still mix driven, the previous they are down some. Our product margins I think you just have to look at them in aggregate over longer term

Steve Scheppmann

Yeah, four to six quarter period.

Operator

The next question is from Matt Summerville from Keybanc. Please go ahead.

Matt Summerville - Keybanc Capital Markets

Good morning, couple of questions. First, Steve, I want to get back to the some of the things you’re providing color on with regards to building out of the expense base in the back half of the year versus the first half. Based on what you’re seeing in your deal pipeline layering in with how we should factor in those expenses, is there any reason to believe that you still don’t see overall favorable earnings seasonality for Teradata in Q4, meaning that’s it is always tended to be by far the highest revenue and earnings quarter for the company?

Steve Scheppmann

Yes. Matt, if I give a little color on that kind of further explained my comments with respect to one of these questions. In the first of the year from a SG&A side, we saw SG&A expenses go up year-over-year $12 million. What I see based on the factors that I described earlier on the new territories proof of concepts, the incentive compensation, customer events and training. I see year-over-year the SG&A going up to low to mid 20s, okay, second half versus the second half last year driven by primarily with those items.

Now, the biggest impact is going to come in Q3. Again because in my prepared remarks, I mentioned, there is a lot of fluctuation or volatility in our expense say reduction initiatives, we actually went down in SG&A Q3 over Q2. Again, that was very focused with some period cost and very focused tied to Mike's direction on managing those costs in 2009. We’re returning to more normalized levels in 2010 again being very sensitive to the pressure on Q3 versus Q4 on that expense structure.

The overall message I want to leave you with, Matt, is that we’re still very focused on improving the efficiency of those SG&A expenses as a percentage of revenue. So, in 2010, you’ll see the efficiency rate, when I say efficiency rate as a percentage of expenses as it relates to revenue, improve in 2010 even over the tight austerity year in 2009. So, again, one of the key strategic drivers of our operating margin expansion is to improve the efficiency rate of SG&A and we’ve should accomplish that for 2010 even with the pressure in Q3 and the more normalized expense levels driven in Q4 driven by those five items I described. Does that help, Matt?

Matt Summerville - Keybanc Capital Markets

Yes, thank you. A follow up on your comment earlier regarding the productivity of the class of ‘08 and ‘09 driving, I think now $75 million an incremental sales this year versus your prior thought of perhaps $50 million. I guess what has happened that’s given you that additional confidence to kind of raise begin the raise that bar back up? More importantly, what is that mean relative to the original target to that to a $150 million in 2011?

Steve Scheppmann

Yeah, Matt, just to clarify you said incrementally it was $100 million of revenue coming from the new territories, but not incrementally in 2010, it was $100 million common from those new territories because we did have some baseline in 2009.

What’s given me the comfort on that is when you look at -- we track this things territory-by-territory when you see the new customer winds coming through and the activity that they’re generating not actually revenue activity, but the how they are moving the balls on the field with respect to those opportunities you're seeing that they are doing the proof of concepts. You see that they are having the appropriate pre-sale activities commencing in those territories. So, as we look at those soft points, those intangibles, and also the performance in the first half it gives increases my confidence that we’re moving towards getting closer to that revenue target of $100 million and position us to get back on line to the closer to $150 million in 2011 from the revenue payments from those new territory. So, the movement since October of ’09, from my perspective, continues to improve that confidence level be able to deliver on those commitments.

Operator

Your next question is from Mark Kelleher from Brigantine Advisors. Please go ahead.

Mark Kelleher - Brigantine Advisors

Great. Thanks for taking the question. I wanted to touch back on gross margins for a second just quickly. You mentioned the positive deal mix drove that product gross margin higher. Can you just tell us what's in a positive deal mix?

Mike Koehler

The positive deal mix it really relates to the types of transactions that we have coming through. We made reference in the past if you have a floor sweep or technology upgrade those might be more hardware focused versus software because you have some of the migration credits that come over. So, if you really look at the deal mix it’s the type of the deals and the margin dynamics on those deals from a product gross margin perspective that might not be diluted by a larger transaction that might be of a hardware upgrade type. So, Mark, those are the really main drivers of it.

Mark Kelleher - Brigantine Advisors

On R&D, you are stepping that up. Can you give some indication of where you going to focus those dollars? What you're looking to do down growth?

Steve Scheppmann

From accounting perspective and I'll have Darryl walk you through on that technology perspective but from an accounting perspective, in the second half for the year we're into FAS 86 from the technical accounting where I capitalize it as internally developed software cost and I am going to be $5million less of my capitalization year-over-year second half 2010 compared to the second half for 2009. So, that less capitalization will put if I can capitalization I have the expense it on the R&D line, so that’s going to be $5 million of that total increase in R&D just purely timing of FAS 86. I will turn over the Darryl on the technology side.

Darryl McDonald

Yeah, some of the other areas that we are investing in from an R&D perspective that we’ve been talking is about we got another a new database release coming up that we are investing. As you know there, we spent quite a bit in enhancing it’s performance and enhancing it’s feature set not only based upon customer requirements but new dimensions that are happening in our space that allow us to be able to handle that and be aggressive in incorporating those features. We also are investing in more of our platform family. So, you’ll see additional products that we will be announcing that they are becoming soon around our platform family.

We have also have work that’s going on in advance development which is really looking at advanced things that we should be considering as a part of our overall stack. This could be a hardware related, software related and includes things like tuck-ins. An example there, we’ve done the couple of recent tuck-ins xqodo[ph] which is going to allow us to enhance our enterprise active intelligence capabilities, our system replication and interoperability. So that’s going to be some advanced development that you’ll see in future products that’s tied to both the data base and the platform family. We’ve also recently did a tuck-in of Kickfire which really is another set intellectual property that allows us to start looking at things like advanced pipelining and this is really going to, going to show up in areas like you’ve seen in the past with this technology. It’s been leveraged all the way from super computers all the way down to gaming devices. It really allows you to put super performance of different things into chips and or the software for acceleration in super performance. So of these are going to be things in advanced development area.

Operator

Your next question is from Alex Kurtz from Merriman & Company. Please go ahead.

Alex Kurtz - Merriman & Company

Just back to an earlier question about new customer wins, how that trend in the quarter again and can you give us some specifics on what regions did well, I mean, what verticals you guys performed well with new customer wins?

Mike Koehler

We don’t disclose the exact number of customer wins, but they were at the highest level for the first half over the past five years. If you really look at what’s happened with Teradata over the past five or six years and one of the reasons why we’re investing in new territories, it wasn’t just to get after the incremental revenue, organic revenue growth from new territories, but it was add capacity across Teradata by having more sales people with time to go focus on new account acquisitions. So, it’s really added to the pace of new account wins. The new account wins were up across all three regions and we had a particularly strong quarter in the US in Q2. Our pipeline is good and this is one of the key benefits the new account wins from the added territories that we've put in the place.

Alex Kurtz - Merriman & Company

Just as a follow-up a thing about the verticals, the telco space obviously there is a big macro tailwind around, mobile data growth. Have you seen a pick up with that vertical? Is there anything you can specifically point to and say, "Yeah, XYZ carrier came to us and did a major upgrade?" Can you just give us some color on that?

Mike Koehler

The communications industry for the first half is up quite a bit. So, globally, it’s up well over 30% and just had a very big Q2. Included in communications industry is also media entertainment and e-business, and e-business has been a very high growth market for Teradata especially here in the US.

The traditional telcos through new account acquisitions, but also in the user base are expanding its utilization of Teradata into new spaces and this is a very good industry for us so far this year.

Darryl McDonald

The couple of the areas of growth have been around getting a 360 view of the customer including network operations and looking at new growth areas like you talked about with their mobile capabilities and the services they can offer there.

Alex Kurtz - Merriman & Company

So is that one is the faster growing verticals in the first half then?

Darryl McDonald

Yes.

Mike Koehler

Yes, it is.

Alex Kurtz - Merriman & Company

Steve, just real quick. Could you break out the stock based comp on just about what was an OpEx and what was in COGS?

Mike Koehler

Alex, we'd like to that on our website and we will have those schedules up in the next day or two.

Operator, we're running out of time here. Can we limit the next callers to one question please?

Operator

Thank you. The next question is from the Nabil Elsheshai from Pacific Crest Securities. Please go ahead.

Nabil Elsheshai - Pacific Crest Securities

Now, I have to narrow it down. Thank you for taking my question. First of all, you guys that said on the Q1 call that some of your conservatism on the employee guidance in the second half was just to lack of visibility. Could you comment on how you are feeling about that visibility going into the second half? Then somewhat relatedly the maintenance declined from Q1 to Q2 which is a little unusual. I was wondering if you could just comment on anything in particular going on there?

Mike Koehler

Yeah, you’re absolutely right, Nabil, we have more visibility into the second half. If you take a look at our revenue guidance, first of all, in the first half, we were up 14% as reported, we were up 12% in constant currency. If you back into the high-end of the revenue growth guidance range of 8% to 10% that implies the second half would be growing 8% in constant currency. So, it would be 12% constant currency growth, the first half with a big pop from the Americas, 8% constant currency growth to second half.

As we said on the last call, the total 50% of our revenue comes from services, and it's hard to move the dial meaningfully on the services in a 12-month period, and services revenues in the first half we’re up 4% in constant currency. So, the second half, we’re looking at mid-single digits growth of our services business, which is over 50% of our revenues. So, that implies the product revenue growth in the second half would be double digits as high as 12% to 13% in order to get to the high-end of the guidance. So, we think this is in a reasonable outcome for our product revenue with the low double digit growth in the second half.

Your related, but also maybe not the same one question was the maintenance, Nabil. the question was our decline in Q2?

Nabil Elsheshai - Pacific Crest Securities

Yeah.

Steve Scheppmann

Nabil, we’re not seeing anything unusual more than unusual than we’ve seen in the past. There is always normal pressures on that but there is nothing unusual that occurred in Q2 that we hadn’t seen prior to that time. It’s just gets back to our performance in ’08 and ’09 on the product side and the new customer wins and we’ll continue to push that and try to position that going forward, but nothing unusual.

Mike Koehler

I would add, there is nothing unusual, but what’s been normal for the past year, yeah and half is there has been pressure from customers around our backs. We have seen maintenance customers choosing to go to a lower service level agreement and with that come some pressure on the maintenance revenues. So, although it's been similar the past year and half, there has been small hits, if you will, over time that in aggregate do add up and does present not a huge tax on our maintenance revenue growth, but there is a tax, if that helps.

Operator

Thank you. The next question is from Brad Reback from Oppenheimer. Please go ahead.

Brad Reback - Oppenheimer

Could you give us there is any update, I know you mentioned some wins where SAP was involve, but now that Sybase is closed any visibility you gotten from SAP on that potential impact your relationship with them going forward?

Darryl McDonald

Sure. We’ve had ongoing dialogue as you can imagine with SAP and our partnership. Currently, we’ve got full commitment from SAP to finish the port of BW on to Teradata in the Q4 timeframe, and then early availability in the first half of 2010. Their commitment is to continue to port and support the major database players in the market place and they’ve confirmed that there is change of plans there with us.

We’ve also been looking at the part of our mobile strategy, how do we support what they are going to be doing with Sybase in providing pervasive intelligence on mobile devices and how Teradata can support that as well. We are also looking to support that with companies like MicroStrategy and Cognos as well. So, so far we are on track and we are continuing our investments and don’t see any change in that.

Operator

Thank you. The next question is from Derrick Wood from Wedbush Securities. Please go ahead.

Derrick Wood - Wedbush Securities

On the appliance side you said there was a major contributor to growth in first half 2010. Can you share with us what the product deal size is there like and what the level of professional services involved or like for these types of deployment relative to your EDW platform?

Mike Koehler

Well, we don’t disclose the number deals. It was meaningful. It was close to 10% of our revenues for first half. So that gives you some color on the amount. Obviously, the average deal sizes are of the magnitude of enterprise data warehouses. The professional services content as a percentage of the deal might be similar, but a lot smaller than enterprise data warehouses. A lot of it depends on what there it’s going in as a add on application specific appliance in an existing EDW environment, like the one example we gave, and with that if might get a lower yield on professional services. However, the appliance is also been very useful for new customer wins starting with an entry level on enterprise data warehouse. The professional services requirements there might be pretty sophisticated make sure that data is right using logical data models, integrating it and get in the profit value out of an entry level enterprise data warehouse. So I hope that gives you a little bit color, Derrick, without the specifics to the questions you just asked.

Operator

Thank you. The last question will be from Greg Halter from Great Lakes Review. Please go ahead.

Greg Halter - Great Lakes Review

I am wondering if you could elaborate and the three components of your deferred revenues and what you saw happen there in quarter?

Steve Scheppmann

Yeah, Greg, in the quarter they reacted very consistently on what I would expect. I've used any 70% benchmark of maintenance and stuff as of total of the deferred revenue were right in line with that 70% maintenance itself comprising more than 70% of my total deferred revenue as of June 30. The movement was very consistent with what I would expect very consistent with last year also. So, nothing an usual on the balance sheet in that deferred revenue item.

Mike Koehler

Okay. Thank you for joining us this morning. In closing I’d like to invite all of you to join us at this year’s partners, users group conference in San Diego, which is by the way the home of our Teradata R&D labs. This conference which is led by our leading edge customers runs from October 24th through the 28th, and it show cases that the world's best in class utilization of enterprise analytics from our customers. So, if you are interested please contact Gregg to register, and thank you and have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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Source: Teradata Corporation Q2 2010 Earnings Call Transcript
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