Teradata (TDC) Q2 2016 Results - Earnings Call Transcript

| About: Teradata Corporation (TDC)
This article is now exclusive for PRO subscribers.

Teradata Corp. (NYSE:TDC) Q2 2016 Earnings Call August 2, 2016 8:30 AM ET


Victor L. Lund - Teradata Corp.

Stephen Mark Scheppmann - Teradata Corp.

Oliver Ratzesberger - Teradata Corp.


Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Derrick Wood - Cowen & Co. LLC

Keith Frances Bachman - BMO Capital Markets (United States)

Wamsi Mohan - Bank of America Merrill Lynch

Bhavan S. Suri - William Blair & Co. LLC

Jesse Hulsing - Goldman Sachs & Co.

Fatima Aslam Boolani - UBS Securities LLC

Karl E. Keirstead - Deutsche Bank Securities, Inc.


Good morning. My name is Erica, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2016 Teradata Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you.

Gregg Swearingen, Vice President of Investor Relations. You may begin your conference.

[065RG9-E Gregg Swearingen]

Good morning. And thanks for joining us for our 2016 second quarter earnings call. Victor Lund, Teradata's CEO will provide some thoughts on his first 90 days as well as Teradata's transformational initiatives. Steve Scheppmann, Teradata's CFO will then discuss our Q2 financial performance as well as our guidance. Also joining our call today is Oliver Ratzesberger, President of Teradata Labs who will be available during our Q&A session.

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, 10-Q and other filings with the SEC.

On today's call, we will also be discussing certain non-GAAP financial information, which excludes such items as stock-based compensation expense, asset impairments, acquisition and reorganization costs, the marketing applications business, which was sold on July1 of this year and other special items. As well as other non-GAAP items such as free cash flow, and constant currency revenue comparisons.

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.

We will host an Analyst Day on November 17th at our R&D facility, which is located near San Diego. We will be providing more information regarding this meeting in the next few weeks.

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

I will now turn the call over to Vic.

Victor L. Lund - Teradata Corp.

Good morning. I'm going to give you some perspective that I have over the first 90 days of Teradata. But I guess in short, I would say that I'm enthusiastic about what I found. I spent a great deal of time analyzing the data around our business and the transformation. I've been on the road meeting with Teradata employees at town halls, with sales team and with every functional organization within Teradata.

I met with customers in the Americas and internationally. I've also met with more than 50 industry analysts who firmly believe that Teradata still has the most sophisticated and powerful analytic capabilities in the market. They also believe that we are on the right path with our cloud deployment options to assist our customers that want to leverage the cloud. I have reviewed our strategic direction with the board, and they concur with our strategy. We are now moving forward to execute our plan.

I'll come back with a little more of the so what after Steve covers the financial results. As you can understand, I've only been at this 90 days, and it would be presumptive of me to go too deep right now. But as we said last quarter, we will have a full presentation ready for our analyst meeting, and we are on track to do that. Steve?

Stephen Mark Scheppmann - Teradata Corp.

Thanks, Vic. Teradata generated results better than our guided expectations in the second quarter. Excluding the Marketing Applications business, which we sold on July 1, 2016, Q2 revenue was $564 million, which was down 3% in constant currency on a comparable basis from Q2 2015. Non-GAAP EPS of $0.71, a meaningful increase from the $0.53 in Q2, 2015 due to the higher than expected revenue and the benefit of our cost management initiatives.

My comments today reflect Teradata's going forward business on a non-GAAP basis, which excludes the Marketing Applications business in 2016, stock-based comp and other special items as identified in our earnings release. Just as we did last quarter on our website, we have provided a 2016 non-GAAP view of our results without the Marketing Applications business.

Turning to revenue by region, excluding the Marketing Applications business in both 2015 and 2016, revenues in the Americas region decreased 6% in constant currency. We continue to see headwinds in regard to large capital expenditures being approved, particularly in the U.S. Although we are working hard on our transformation, particularly on our Hybrid Cloud offerings and how we interface with and provide value to business users, we expect this headwind related to large IT capital expenditure projects to continue.

Our international region increased 2% in constant currency. Within international EMEA revenue was down 3% in constant currency while APJ revenue increased 10% in constant currency.

There has been a lot of attention on the impact of Brexit, I will provide a few specifics about our UK business. Revenue in the UK was up 3% in constant currency in the second quarter. We had good performance in the U.K. in Q2. However, we expect headwind in the second half of the year in the U.K. due to the devaluation of the British Pound. To provide context in 2015, U.K. contributed less than 5% of Teradata's total revenue.

Turning to gross margins, product gross margin in the second quarter was 60% in-line with our expectations but down from the 65.6% in Q2, 2015 due to deal mix. Services gross margin in the quarter was 48.5%, up from 46.3% in Q2, 2015. Services margin improved due to better consulting margins, as well as the exit of the Marketing Applications business. Overall gross margin was 53% in the second quarter compared to 54.3% in Q2 2015.

Turning to operating expenses, SG&A expense of $132 million was down 26% from Q2 last year, the decrease was primarily due to our cost management actions, as well as the exit of the Marketing Applications business. Research and development expense of $36 million in the quarter was down 31% from the prior period. The decrease was largely due to the cost management actions we commenced in Teradata labs last year, as well as the exit of the Marketing Apps business this year.

We continue to expect R&D expense for the full year to be down 10% to 15% as reported. However, due to the investments associated with our strategic growth initiatives, we expect R&D expense will increase on a comparative basis, excluding Marketing Apps, as we move into the second half of the year, as well as into 2017.

As a result of all of these items, operating margin for the quarter was 23.2%, a strong increase from the 17.2% in Q2, 2015. The improvement in operating margin was due to our cost management actions and higher services gross margin, as well as the exit of the Marketing Applications business.

Our non-GAAP effective tax rate for the second quarter was 27.1%, comparable with the 27.6% in Q2, 2015. Looking forward we expect our full year Non-GAAP effective tax rate to be approximately 27%, with the actual tax rate being primarily dependent upon the ultimate earnings mix. GAAP EPS was $0.49 in Q2. This compared to a GAAP EPS loss of $1.87 in Q2 2015, which was driven by the goodwill impairment charge related to the Marketing Applications business. Our non-GAAP EPS was $0.71 compared to $0.53 in Q2 2015.

Turning to cash flow. Net cash provided by operating activities was $99 million in Q2 2016 versus $80 million in the second quarter of 2015, due to a net favorable year-over-year change in working capital.

In the second quarter, we had $27 million of capital expenditures and additions to capitalized software, the same as in the second quarter of 2015 resulting in free cash flow of $72 million versus $53 million in Q2 2015. We continue to expect full year free cash flow to be equal to GAAP net income excluding the impairment charges or up to $50 million higher, which at the high end of our range would approximate $270 million.

Moving now to the balance sheet. We had $909 million of cash as of June 30, 2016 of which more than 98% is held outside the U.S. This is slightly down from the $917 million as of March 31, 2016 as we used $80 million of cash in Q2 to completely pay off our revolving credit facility.

We moderated our repurchase activity in the second quarter as we had been quite active in Q1, as well as in 2015, which enabled us to get to the shares repurchase that we had planned for. During the first half of the year, we bought approximately 2.6 million shares for a total cost of approximately $62 million. As of June 30, we had approximately $528 million of share repurchase authorization available.

Before I turn to guidance, I want to provide a little color commentary on what we see in the market. Our revenue has been impacted by our customers' focus on less capital intensive options like cloud and other alternatives, including other purchasing options such as subscriptions, rental and other usage-based models.

Many customers have delayed or reduced On-Premise purchases in order to evaluate Teradata's cloud, public cloud and other consumption options. Our current outlook for Q3 and the remainder of the year includes new cloud opportunities with the vast majority with current Teradata users, as they desire to start building out their hybrid cloud environments. This is a good start to our initiatives associated with different solutions and usage-based subscription offerings that make it easier for our customers to consume Teradata.

To provide more color, we are seeing an interest in our term rental or usage-based utility offers. For example, in Q2, we signed an $11 million contract with a well-known airline utilizing our rental term offering that will result in revenue being recognized ratably.

In July, we closed a significant transaction with a large well-known healthcare company using a utility-based model, in which revenue will be recognized based on usage.

In addition, we have many other customers evaluating these usage-based pricing alternatives. This is not unexpected and is aligned with our transformation. But, as you likely understand, this will begin to impact our year-over-year revenue comparisons as some of the revenue we would have normally recognized in a given quarter will now be spread over a number of periods.

That said, we are pleased with our Q2 results and expect Q3 revenue in the $550 million to $560 million range. We expect non-GAAP EPS to approximate $0.60 in Q3 as the benefits of our cost reduction continue. But we will see the increased investment for our new initiatives reflected in our operating results beginning in the third quarter.

We expect product gross margin in Q3 to be approximately 60% and services margin in the mid 40%s. We expect as reported total operating expenses to decrease approximately $20 million year-over-year in Q3 with reported R&D expense being up slightly year-over-year and up sequentially from Q2.

For the full year, we continue to expect revenue, excluding Marketing Applications business, to be in the $2.25 billion to $2.32 billion range. Although we had a good first half in the terms of EPS improvement, our full year expectation for non-GAAP EPS remains the same at $2.35 to $2.50, since we will begin to see the impact of our increased investments in our operating results in the second half of the year.

We have made good progress in our cost reduction initiatives, as you can see from our results, and are now shifting from a cost-reduction phase to a more responsive cost-management phase as we properly invest for Teradata's future to better align with the changing marketplace.

Our future investments, which we'll provide greater details on during our Analyst Day in November, will support our cloud offerings, our analytical solutions, and improve the effectiveness and efficiency of our infrastructure and support functions. Although these planned investments will begin to impact our results in the second half of 2016, they will become more meaningful in 2017.

In closing, market changes have disrupted business as usual for many companies, and the companies such as Teradata that flourished in the past must adapt. The good news is that Teradata has best-in-class technology, smart, and talented and customer respected people, and outstanding customers who tell us they are going to continue expanding their On-Premise data environments while also leveraging the Cloud. They are looking for us to deliver smarter, more flexible and easier to use options to consume Teradata. We are on it, and fully intend to deliver both for our customers and our shareholders.

Now I'll turn it back over to Vic.

Victor L. Lund - Teradata Corp.

Thank you, Steve. I would now like to provide an overview of our business at a level I am comfortable sharing at this point in time. First, our technology is strong and our customers want and need it. Our customers are among some of the largest and most aggressive users of analytics in the world, and they believe our offerings are a key part of their long-term strategy. They see us as a trusted adviser to help them sort out the best ways to deal with the explosion of data. They trust us because we bring scalable solutions that work.

Second, I have seen firsthand that Teradata has very talented people who are the best at what they do, and they are hungry for change. They are passionate about our new direction, our technology, and what we can do for our customers. And they know they are the best at bringing analytics and data together for the customer's advantage. This isn't just my view, but the view of the customers I've had face-to-face meetings with.

So if this is true, why has our revenue been challenged? Our product has remained product centric and our sales approach too IT focused. This is inconsistent with where the market is going. Some of our customers believe that we are unreceptive to the new ways they want to buy, consume and deploy technology. This is absolutely not true, and we are going to change this misconception.

We have made dealing with us harder than it should be. We need to update our infrastructure so that we can be more efficient and more responsive in serving our customers.

So the question is, what are we doing differently? We have refined our strategy to be even more customer centric, giving customers what they want and how they want it. We will become more focused on business outcomes and be more consultative in our approach. We will be riveted on helping business users solve their challenges, rather than leading with technology. This approach has been very well received by my initial customer visits, and will position us as a trusted advisor with both the business and technical leaders in our customer's organizations.

Our strategy is based around a core belief that analytics and data unleash the potential of great companies. To empower companies to achieve higher impact business outcomes, we will be providing differentiated business solutions and analytical architecture expertise that pull through our technology solutions. Our core database technology remains the key element of our strategy, and we will continue to deliver our best-in-class data analytics at scale.

Since business users are now a key buyer of analytics, we are shifting our emphasis towards delivering high impact business solutions for our customers. In doing so, we will leverage a more consultive solution selling approach to identify and deliver value to business buyers supported by our business and industry consulting.

In the Americas, we have restructured our business and industry consulting practice into a more centralized organization so we can leverage these resources across industries and deliver a consistent message to our customers.

We see growing demand from business buyers for one stop shop, for analytics that can create high-value business outcomes and many of our customers look to Teradata for this. We will focus our analytic consulting on solving customer challenges where we have expertise and assets. By capturing the IP from these engagements, we will be able to leverage these use cases with other companies. Our opportunity lies in our ability to scale and monetize these solutions.

As more companies begin to explore various Open Source, Cloud and deployment alternatives, they need a partner that can help navigate and optimize their analytical architectures.

Our years of implementation experience in Enterprise, class, analytic infrastructures and data integration, along with Open Source experience brought by Think Big enable us to help customers achieve their analytical business objectives.

We will provide broad technology architectural consulting and migration services to guide their data strategies. By objectively discussing the benefits of Open Source, Cloud and On-Premise deployment options, along with the optimal placement of data across the ecosystem, we can make their architecture easier to use and deliver solid benefits, thus giving them higher returns on their investments in technology and related solutions.

While having a flexible analytical ecosystem is increasingly important, our customers tell us they want to continue to rely on Teradata for sophisticated workloads and our solutions, including on-prem systems will continue to be a major component of their ecosystem.

In addition to continuing to improve the performance and value of our market leading database, we are aggressively extending our portfolio of technology solutions to deliver an end-to-end analytical ecosystem across the hybrid cloud architecture to accommodate our customer shifts and buying preferences towards the cloud.

Our cloud strategy is focused on delivering three types of offers. First, we have the Teradata Software-Only available in the public cloud for the do-it-yourself segments that want to purchase Teradata software and deploy it on the public cloud.

We have further accelerated our release of the Teradata Data Warehouse on AWS running MPP and expected to be available on AWS later this quarter. This is not a scaled-down version of Teradata, it has the same performance benefits of our Teradata MPP on-prem system routed in our superior processing engine, shared-nothing architecture and best-in-class performance optimizer. And in test of real world consumer queries it proves much more powerful than any other major competing cloud database today. Additionally, we are planning to release Teradata database on Microsoft Azure running MPP in Q4. And we will soon have Aster available on AWS.

Second, we have our Hybrid Cloud solution, which meets the needs of companies who have hybrid On-Premise and Cloud environments either as an in-state goal or as an interim path towards 100% cloud deployment.

Third, we are offering Teradata Managed Cloud Solutions for the do-it-for-me segment of the market. This is the most strategic opportunity for Teradata in the cloud where we are not just selling our technology, but rather providing a full managed solution.

We will leverage not only our own data centers as hosting options, but also the public cloud to provide infrastructure as-a-service capabilities to achieve broader reach and align with customer cloud preferences. We will extend our managed cloud business with new entry level and higher performance/service level options. We are also on track to launch Teradata Managed Cloud in Europe later this quarter, thus expanding our reach globally.

To accelerate our cloud strategy, we have fundamentally changed our development and engineering process to provide our customers with the rapid releases of functionality required to meet their business growth. Additionally, we have recruited top cloud talent to augment our team.

As we are creating more flexible options to better align with how customers want to buy and deploy Teradata, we are also realigning our direct sales-force with the biggest revenue opportunities and highest probabilities of success. These efforts will give our teams more time with our customers, support better coordination and improve productivity.

Further, we are going to see that our sales teams are properly supported with the tools they need to properly explain our strategy to their customers. The largest companies in the world remain the best revenue opportunity for us, as they have the most complex analytical requirements and the need to scale.

Further, they drive the vast majority of global IT spending. This is Teradata's sweet-spot where we can provide differential capabilities to solve a broad range of problems and where our value proposition is most compelling.

But we haven't done a great job of capitalizing on the revenue opportunities here. For example, we have less than 40% of the global 500 as our customers and our share of wallet in these customers is smaller than it should be. Concentrating on these larger revenue opportunities with a solution-oriented focus will require a very different sales approach in how we build account plans and how we market to our customers.

Evolving our go-to-market approach will better position Teradata with both business buyers and IT buyers and increase wallet share with our existing customers as well as add new ones. Business buyers will look to Teradata for analytic solutions tailored to their industry and business problems. Our new Hybrid Cloud will allow IT buyers to have the highest performance possible, deploy the most agile way and at the lowest cost of total ownership.

As we execute our strategy and ramp our business solutions in Hybrid Cloud offerings, we intend to make it easier customers to procure and deploy Teradata by offering multiple and flexible consumption and pricing options. This is an area where we have more work to do to ensure that we deliver fair value to our customers while at the same time seeing that Teradata is properly rewarded for the value we deliver. We will provide more information in this area on our Analyst Day.

During the presentation, we will be able to demonstrate that our initiatives have both near-term and long-term returns. And while it is true that our complete strategy implementation will take time, it will not take long before you start to see the results of those implementations.

Steve pointed out that we have made good progress on our cost reduction efforts, and are now shifting to a responsive-cost management process. We need to make sure our initiatives get the funding they require to better align with the changing marketplace. However, these investments will only be made if they accelerate the return of our revenue growth or reduce our cost footprint going forward.

To support our successful transformation, we're also making organizational changes to ensure that we have the right talent in the right positions. And we will continue to provide you with more information on these changes, as well as our go-to-market approach.

I am well aware that simply creating plans does not make them happen. Rest assured, we have identified tasks with clear owners and are defining measurable objectives to drive our long-term success while still focusing on short-term results. In order to provide more transparency to our transformation roadmap and success, we will provide actions, metrics and a multiyear financial model at our Analyst Day.

Last quarter I told you I would take the first 90 days to evaluate the business. As you've heard today, that's well under way. Our top priority now is driving our business forward, executing on our transformation and returning greater shareholder value.

Given this focus, the Board and I have determined that it is premature to initiate a CEO search at this time. We will let you know when we begin that process. And when we do, the Board will be deliberate in its action.

In closing, the new Teradata will empower our companies to achieve high impact business outcomes through analytics of scale on agile data foundations. We will be business outcome focused and consultive in our approach, serving as trusted advisers throughout the organization.

As we look forward, we will develop world-class cloud capabilities and services to make Teradata available no matter where or how our customers want. Refine and execute our go-to-market strategy to optimize our revenue opportunity.

Provide analytical business solutions that deliver high-impact business outcomes. Create an environment and culture that supports a nimble and effective organization driving innovation. And, finally, and very importantly, ensure our strategy delivers long-term revenue and earnings growth. I can assure you that we are advancing on all fronts and are underway executing against our transformation.

And with that, operator, we are ready to take any questions.

Question-and-Answer Session


We ask the participants to limit themselves to one question each. Thank you. Your first question comes from the line of Katy Huberty from Morgan Stanley. Please go ahead.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Yes. Thanks. Good afternoon or good morning. As you shift focus to investing in cloud and realigning go-to-market, how should we think about overall operating expenses over the long run? I know you commented on R&D up in the back half in 2017. But should we also expect that OpEx grows particularly next year?

Stephen Mark Scheppmann - Teradata Corp.

Yeah, Katy. Yes, as we see the investments in cloud analytical solutions, the infrastructure side, yes, the pure OpEx number will be increasing in 2017. Our opportunity and our goal is also drive that revenue number be it in a subscription model or be it on an On-Premise model. But to provide you the metrics to demonstrate to Vic's words that those operating expense increases are going to generate future revenue growth or on the other side enhance our efficiency from an operating expense perspective. But from a pure OpEx perspective in 2017, they will go up.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Okay. And as part of your transformation, I assume you're looking at many options. In that context are you free to repurchase shares? And if so, why are you spending so little, particularly in the June quarter on the buyback? Thanks.

Stephen Mark Scheppmann - Teradata Corp.

Yeah, Katy, there's no restriction on the repurchase of shares. We still have over $500 million of authorization. As we are going through our strategic transformation, strategic objectives and initiatives, we are looking at and evaluating make or buy situations in order to enhance – or to get to the market faster with some of our initiatives.

Now, remember, the majority of our cash, over 90%, is international and we use U.S. cash on that. But we do have the revolver, so at this point in time, we're maintaining our flexibility from a capital structure perspective to make sure that we have the dry powder left – or dry powder available to us for these strategic initiatives. As we lay this out in the Analyst Day, you will see both an operational and a capital structure strategic plan going forward.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Okay. Thank you. Congrats on the quarter.


Your next question comes from the line of Derrick Wood from Cowen & Company. Please go ahead.

Derrick Wood - Cowen & Co. LLC

Thanks. Steve, you mentioned that some customers are delaying deals in front of your Cloud offering. I know you guys have a full MPP version coming out in the Cloud soon. How are you expecting the uptake from this new service? Do you have customers in beta? Are they ready for some sizeable moves? Or do you think this will be more of a toe-dipping exercise with a backup workload and it will gradually move into the Cloud?

Stephen Mark Scheppmann - Teradata Corp.

Yes, Derrick, I'll have Oliver comment on the technology side of that. Then I'll close on some of the financial implications side.

Oliver Ratzesberger - Teradata Corp.

So on the technology side, we are releasing Teradata MPP on AWS this quarter. We actually have been testing for the last several quarters. We have several customers that we have Alpha and beta tests going on, a lot of positive feedback. A lot of -- a lot of customers that are really looking to leverage this deployment option in addition to On-Premise, and it's really a core component of our Hybrid Cloud Storage.

So it is something that we're actively working on, that is coming out very rapidly that we have tested for several quarters and we are very confident that customers will indeed move to that very rapidly.

Stephen Mark Scheppmann - Teradata Corp.

Yes. And Derek, what I'm seeing in the funnel is I'm seeing exactly what Oliver just described is that the customers are looking to build out. The new opportunities on this Cloud is really on our Hybrid Cloud offering. And so these are, majority of our existing customers looking at, as you said, toe dipping in that.

But, again, we're not seeing it as cannibalization of that On-Premise. We're seeing it as an addition, additive to that Hybrid Cloud solution. And so we're very optimistic with the funnel activity and early stages is quite positive with respect to the reception of this Hybrid Cloud offering.

Derrick Wood - Cowen & Co. LLC

Great. And maybe a follow-up for Vic, just a little bit more color on the changes in the sales force would be helpful. Are you building any kind of new inside sales that could drive more volume business in the Cloud or is it really still a focus on strategic accounts and maybe layering in people that can go after business? Maybe a little more color on the sales force changes would be helpful.

Victor L. Lund - Teradata Corp.

Great. Sure. So, in our go-to-market, we got in and I – how do I say this? I don't have the whole half an hour to go through this. But I guess our go-to-market, one of the biggest eye opening things I found was that we basically didn't support our field from a corporate perspective in terms of education or about where we were going and strategy. Our go-to-market approach, we didn't have any central approach or anything like that.

So the initial thing of what we're doing is just simply getting back to real basic blocking and tackling from a go-to-market perspective, looking at our accounts and how we align where we are and going at it.

So near term, it's that, longer term obviously we have to build out these capabilities. And this is one of the investments we have to make going forward is to get a backend support for all of that.

I think the second part of your question revolved around what is our targeted market. And I think I said in my opening comments, and so just to be clear, we believe that in the top 400 or 500 accounts worldwide is our sweet spot. That's driven because of two reasons. One they account for a huge percentage of the relevant technology spend for us.

They also appreciate and want the help in very complicated analytic solutions, and we're capable of delivering that. And our share of wallet in those accounts. It's not just a number. But in the accounts we have, because we have been so resistant to change, they haven't looked for us to expand our presence in them.

And I've got to tell you from my visits with early customers, just simply the fact that we admit that Open Source exists and Hadoop is there and where they are and that the Cloud is coming has made them much more receptive to doing business with Teradata.

So on all fronts, I think we're at it. It's a little of what I said. Some of it will come earlier. Some of it will take a little longer. But I really am quite enthused about what I found about our people, our technology and our customers' reception to it.

So I hope that answers. We obviously owe you some more detail around this at the Analyst Meeting, and we'll do that. By nature, I only want to tell you what I know to be true, but I tell you that I know to be true that our customers like us that we have the capabilities, and I really am quite thrilled.

I told a lot of the folks around here the worst thing that could happen from my perspective is that I would have walked in and found everything perfect, because then it would have been hard to figure out where we're going to go. But we have a lot of near- and long-term opportunities to return Teradata to where it should be, and our people are enthusiastic about it as well.

Derrick Wood - Cowen & Co. LLC

Great. Thank you.


Your next question comes from the line of Keith Bachman from Bank of Montreal. Please go ahead.

Keith Frances Bachman - BMO Capital Markets (United States)

Thank you very much. I had two questions as well. I wanted to return to an earlier question is does the advent of the cloud delivery that you're focusing on mitigate some of the challenges, at least that we hear of deploying the technology. And that is to say, I agree with you, you're targeting some of the largest Fortune companies. You're at 40% penetration rate. But some of the dynamics are that getting Teradata systems up and running is difficult, to load it and whatnot. And it's also expensive. So if you're trying to win new workloads, I understand the message surrounding Hybrid Cloud, but if you're trying to win new workloads with new customers, is the Cloud going to help you get there?

Oliver Ratzesberger - Teradata Corp.

This is Oliver. Yeah, I'm going to take that question. Absolutely. In fact, when you look at how we look at Cloud and our cloud first strategy of how we develop technology and have been so for the last couple of quarters, it is not just that we run Tera technology in the cloud. It is really about the deployment options, def ops, the agility that comes with that. We are now able to extentiate an entire ecosystem of multiple Teradata systems; Hadoop, Aster (38:17), other technologies in as little as 25 minutes in a cloud.

And what that allows us to do is if a business has an idea, wants to try something out, they can stand up an entire ecosystem within minutes in less than an hour. That previously would have taken them months or longer to go through capital requests to install the systems, to load that data, to set everything up, right.

So cloud brings a lot of opportunities to our technology. And we're very excited. And we're using it even internally. We have gone to a quarterly Hackathon set up where we extentiate these kinds of technologies on a moment's notice note data from customers and then interact with that data within a matter of hours and days what would previously have taken a much longer time.

So that is a big enabler for us to take our technology into new use cases that previously we weren't agile enough to deploy that.

Keith Frances Bachman - BMO Capital Markets (United States)

Okay, great. Thank you for that answer. I'd like to ask my follow-up question, and just talk a little bit about product gross margins. I understand this quarter you indicated mix went against you. But as you think about the strategy that you're laying out over the next number of quarters, how would you anticipate product gross margins, the puts and takes, including the advent of the subscription model?

Stephen Mark Scheppmann - Teradata Corp.

Yes, Keith. And with the qualifier, you'll see a lot of that detail on the November 17 meeting. But for the remainder of 2016 here, we're looking at product gross margins with the mix that we see and even with some of those subscription models or usage models in play in Q3, Q4, that product gross margin for the second half of the year should be around 60%, consistent with our expectations coming into the year.

So I'm not seeing anything at this point in time that's going to change that significantly. It really comes down to the options for the different type of scenarios that customers may elect. And we'll have more clarity, more transparency on that product gross margin going into the future as we give you that multi-year financial roadmap. So, again for 2016, I'm still seeing it right where our expectations are at about 60%.

Keith Frances Bachman - BMO Capital Markets (United States)

Okay, fair enough. Thank you for taking my question. Cheers.


Your next question comes from the line Wamsi Mohan from Bank of America/Merrill Lynch. Your line is open.

Wamsi Mohan - Bank of America Merrill Lynch

Yes. Thank you, good morning. So with your upcoming release of MPP solutions on AWS and Azure, how do you view the need to maintain the entire portfolio longer term and how much overlap in investment between the on-prem and Cloud based offerings or can you give us some split of how you're thinking about the investments on those?

And then do you see any deferrals in the quarter that you were expecting to see? If you could comment on those rolling deferrals that you commented on last time? And I have one more follow-up.

Stephen Mark Scheppmann - Teradata Corp.

Yes, Wamsi, before Oliver jumps in on the investments on the cloud or on the platforms, rolling deferrals nothing unusual in the quarter. We still keep seeing them. But the gives and takes makes Q2 pretty consistent with the prior quarter.

Oliver Ratzesberger - Teradata Corp.

Yes. On the R&D investment side, Hybrid Cloud is really the big story for us and we see a lot of use cases where customers want to maintain a presence in a datacenter for specific workloads. They want to leverage Cloud or various Cloud platforms for new types of workloads, new types of data.

The beautiful story for us is that, we have been in this transition or transformation to go to a software-only platform really over the last several quarters. And the software that we actually run Teradata MPP on the AWS and soon on Azure is actually the exact same software that we run on our for example, IntelliFlex platform in the data center. And that really allows us to have a single development stream that has a cloud first focus. And we even treat now our On-Premises systems as if they were Cloud systems. And so that allows us to really focus investment dollars into this but not having to deal with multiple different deployment options.

Wamsi Mohan - Bank of America Merrill Lynch

Thanks. So, Vic, last quarter you mentioned, you viewed your role as being completely engaged but not a long-term one. So is it just the sense of urgency in your transformation that you view the CEO search as disruptive? And what milestones should we be looking at or tracking or you are looking at and tracking to determine if and when there will be a CEO search?

Victor L. Lund - Teradata Corp.

Wamsi thank you. So, yes, focus is a very important thing. And my role, I'm not going to be here for 10 years or however long. I think the change from last quarter is simply that when I got into the details, you never know exactly when you come in what you're going to find.

I have a great sense of urgency. The organization is rallying around what that is. I have promised the people at Teradata that I'm not going to come in and start something and leave when it's half done, and so I'm going at it. I – we need to work down this and figure out where it is and then figure out exactly when is the right time to start that CEO search and when we should do.

I will reiterate when we do that, there are internal candidates and then the Board will be deliberate in what they do. Obviously they have what they have to go through. But I guess just we have a lot going on right now. And it's making progress. We're getting traction.

And the Board asked, and I agreed, that we will think about that when the time is right. But we don't want to lose focus on the traction we've got going and the progress we're making. I still remain enthused about this and excited to go forward.

So when the time comes, we'll make that announcement and go forward. But for right now, that is where we are. And when the time is right, we'll do it. But we're going to do it when it's right for the business, and that obviously means for the shareholders.

Wamsi Mohan - Bank of America Merrill Lynch

Congrats on the margin then and the progress made.

Victor L. Lund - Teradata Corp.

Thank you.


Your next question comes from the line of Bhavan Suri from William Blair. Please go ahead.

Bhavan S. Suri - William Blair & Co. LLC

Hey, guys, thanks for taking my question. Just one product-specific question and then one partner-related question. On the product side, when you look at the Cloud offering, just some sense of performance meaning, does it scale linearly and does it deliver the same sort of per compute processing power that the core solution has, or would you need things like Amazon to upgrade the interconnect to get that performance. I expect that this one is for Oliver, but I'd love to get some thoughts on sort of as you're testing it, what sort of scale and performance are you seeing from the Cloud solution?

Oliver Ratzesberger - Teradata Corp.

Great question. And it's something that we focus a lot on in fact for the last several quarters we have been testing very heavily MPP on the various Cloud platforms.

We are actually quite happy with the performance that we're seeing in the Cloud. In fact, we have done benchmarks where we compare against other leading offerings in the Cloud, and we see that we consistently outperform the other offerings by orders of magnitude.

We are seeing that the advantage that we have with the Teradata software, especially with the optimizer, scales extremely well in the Cloud. We are seeing that linear scale that we have in our On-Premises solutions. It's just that the units in the Cloud are usually smaller, you add more smaller units together to get to the same performance footprint that you have in a data center.

But when we compare it node-for-node compared to other technologies that run in the Cloud, we see phenomenal performance. And in fact, we just took some of the industry analysts through it two months ago. And the feedback from them was just – they were in awe. What kind of performance Teradata can produce in something like the AWS Cloud. And we are seeing very similar performance on Azure.

And, yes, there's differences between AWS and Azure in terms of what their backend is, and that is reflected in the performance on their part, whatever the performance is that we see in the cloud, we can leverage it to its maximum.

Bhavan S. Suri - William Blair & Co. LLC

That's helpful. Thank you. And then my follow-up, maybe this is for Vic, your services model historically has been a couple of select partners like maybe IBM Global Services, but typically Teradata has performed a lot of the services for implementing Teradata systems. You've now acquired, or recently acquired, another services company in the big data space.

But as you deploy and sort of think about going a little lower market and deploy this across multiple clouds and try to approach a customer base with multiple use cases, are you guys thinking about changing the partner strategy? Would you guys be willing to now partner more with some of the global SI's and folks like that for Teradata implementations, or do you still plan to keep the services component largely in house?

Victor L. Lund - Teradata Corp.

Well, so let me step back just a little and kind of answer that from a little broader perspective. So, yes, we have done, brought most of our service implementation ourself; we've used others. The answer to the question, and I'm not trying to be cute about this, is we have to look at a business case by business case and figure out what we do, we'll do whatever makes sense.

But remembering that we are a trusted advisor. One of the key things we have to do when we engage with a large company is that we have to make sure that we deliver what we say we will deliver and be able to deliver it at scale. So we will do nothing that will compromise that. It is one of the key tenants we are going after.

The most recent acquisition we did in Big Data is an adjunct to our Think Big. Both of these companies, and they are -- ours are Open Source focused. And we are doing that to expand our footprint. As you all know, these very bright people are hard to find in the world and we've had the good luck of being able to acquire some of them through acquisitions. They're smaller companies, very smart, aggressive entrepreneurial people. And it also helps us increase the last one was to increase our footprint internationally.

So we are open to whatever from our partner -- what partners we work with. But we are – we want partners and we want them that are consistent with our strategy. And I get back to that -- the key tenant for us is simply that we have to be able to deliver what we say we can at scale without any hiccups. And so we'll do whatever makes sense, but right now that's where we are.

And then -- and it's just because we're dealing with big customers, and that's what they all like about us. When I'm out talking to them, they all say, you guys do what you say you're going to do and it's scalable. And I think a lot of our customers are starting to find out that Open Source and Hadoop are great, but that requires smart people on top of them to make them work. And in some cases there are people promising things that when they get in, they're simply aren't scalable. They can do them on a small scale, but when you have to get them up, they just don't work.

And so this is one of our key differentiating points in the market. And so we are not going to sacrifice that.

Bhavan S. Suri - William Blair & Co. LLC

Got it. That's helpful. Thanks for taking my questions, guys, and nice job there.


As a reminder, we ask that participants limit themselves to one question each.

Your next question comes from the line of Jesse Hulsing from Goldman Sachs. Please go ahead.

Jesse Hulsing - Goldman Sachs & Co.

Yes. Thanks, guys. I really appreciate the question. This is probably for Steve. With product gross margins coming in low for Q2 and down I think 500 basis points year-over-year, did you have any big floor sweeps or anything unusual that would have pulled that down?

Stephen Mark Scheppmann - Teradata Corp.

No, Jesse, no big floor sweeps have pulled it down. We had one transaction that was more related to an ELA customer and it was more hardware centric, large transaction. It was what we had anticipated, what we had expected, as we looked out into this year. So nothing unusual that would indicate that I'm not comfortable with that product mix in the second half of the year being around 60%.

Jesse Hulsing - Goldman Sachs & Co.

Got you. And a quick follow-up for Vic. I know it's early and you have only talked to customers for a few months, but in your conversations, do you get the sense that the addressable wallet in your large customers is stable, or do you think that Cloud and Open Source are reducing the spend on analytics platforms in aggregate in these big Global 2000 type organizations?

Victor L. Lund - Teradata Corp.

So, I guess, not an easy answer, right. But I actually think quite the opposite. I think that we have a lot of opportunity in these big accounts because we have to be flexible. We're going at it. We're going to solve through analytic solutions what they want. They have more data, not less, that they need help.

In a consultative nature, that means that you're going to drive revenues a different way. Our customers are trying to understand how to get into the Cloud, all of that. So I think there is a lot of opportunity coming down the road in that regard.

I know it seems hard at times to believe, and it was hard for me a little bit at first when I got out, but the two key issues I heard from customers when I came down was, one, so you guys are going to go to the Cloud. You understand that there's new things coming. You're going to help us work with that. And I said, yes, we're going to.

And the amount of uncertainty there was about that in the marketplace surprised me, and I think a lot of our customers actually were worried about that. And I think the second issue that came down, and they were thrilled to hear, and that is that we are committed to driving this business forward. Teradata is going to be around for a long time. We are going to be their partner and be there to help them.

And I think just hearing that has made them more receptive and it's been easier for our folks to get in. So when I say I'm enthusiastic about it, I really am. I mean, it's not that we've got to perform. We've got to do what we say we can do. We got to do all of this stuff we're talking about, right?

But we have the capability and the people already inside the business to execute this strategy. Now, are we going to need more of them going forward? Sure. But that more will be when we leverage and grow revenues. We're just going to have them in the field.

So I'm really enthusiastic. Our guys we get in with Open Source, from Think Big are great, they're smart, they're fast, people love them. So people are viewing us because we are coming with real offerings that demonstrate a different Teradata. And so I think that's helped us a lot.

Jesse Hulsing - Goldman Sachs & Co.

Thanks, Vic. I appreciate it.

Victor L. Lund - Teradata Corp.



Your next question comes from the line of Brent Thill from UBS. Please go ahead.

Fatima Aslam Boolani - UBS Securities LLC

Good morning. Thank you for taking the question. This is Fatima Boolani on for Brent. A question for Vic, Vic, you mentioned you spent the better part of the – your first 90 days talking to customers and partners worldwide. And in that context, the international performance of the business has continued to be strong. So I'm wondering if you can shed light on what type of buying behavior that you're seeing that is different than from domestic trends or perhaps there is an execution playbook that's different domestically. Any color there would be helpful and a follow-up question for Oliver, if I may?

Victor L. Lund - Teradata Corp.

So, yeah, I mean, I talked a little about that. And this is real, I think real simple. Yes, is the answer to international. They have led a more consultative practice over there, over the last couple of years, and they've led the way we are here in early stages of that, I would say.

But so, yes, we did have a little different strategy over there. And we did have more of a backend support in Europe. And actually the guy that was leading that Michael (55:30) is coming to the U.S. to do that for us worldwide. So, yes, I'm supportive – 100% supportive of our strategy. And so absolutely we saw it. And it was very encouraging.

Fatima Aslam Boolani - UBS Securities LLC

That's very helpful. And a question for Oliver, regarding the IntelliFlex architecture, now that fundamentally sort of decoupled the storage from the compute and would I'd imagine necessarily be disruptive to your overall hardware business since it sort of deemphasizes the product families underneath. I was hoping you can help us appreciate the headwinds and the tailwinds if more customers adopt IntelliFlex and what the economic realization is from the adoption of IntelliFlex, and perhaps a lack of adoption on On-Premise appliances?

Oliver Ratzesberger - Teradata Corp.

So we are actually very excited about IntelliFlex, and so are our customers. We have just released it this quarter. We're talking to a lot of accounts around the world. It is really reducing friction in installing Teradata Systems. It is very much bringing Cloud-best practices into the data center, growing storage and compute independently. It also helps us internally simplify our development roadmaps and collapse various different product lines into IntelliFlex which makes us more nimble, faster time to market, and it allows our customers to more precisely implement what they need and do that much, much faster.

So the hardware business for Teradata by the way is not going away, right. The Hybrid Cloud is strong backend is the On-Premises solution, and we have enough indications from our large customers that they have no intention of moving everything into the Cloud. Right? And as such, they appreciate what we're doing with IntelliFlex and what we will be showing with IntelliFlex over the upcoming quarters is new technologies that we can implement with that. And we can bring those to market in a much, much faster way than we have done before.

So a lot of excitement in the company around IntelliFlex, it allows us also with our managed Cloud to bring IntelliFlex into there and have the same performance footprint that we have in an On-Premises solution. And that really opens up a lot of possibilities for us as a company.

Fatima Aslam Boolani - UBS Securities LLC

Thank you.


Your next question comes from the line of Karl Keirstead from Deutsche Bank. Please go ahead.

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Hi. A question for Steve. A couple of cash flow questions. I think you mentioned in your comments the upper-end of your free cash flow guide is still $270 million, if I heard you correctly. I think you did $297 million through the first six months implying that your second half free cash flow might be down. Could you just explain why that would be?

Second and related, I think Teradata did $40 million of special acquisition, integration and reorg costs in the first half of 2016. Are you anticipating more of these quote one-time costs in the second half? And then maybe lastly, you mentioned on a couple of occasions the need to update your infrastructure. Could you elaborate on what that means and will that have any CapEx implications for second half and 2017? Sorry for all of those questions.

Stephen Mark Scheppmann - Teradata Corp.

Let me get the middle one on the special charges. Yes, we expect those to be declining in the second half of the year. And so, yes, the first part was the ramp of the six months. Again, as you heard Vic say, we're now in the execution mode and so expecting that to be declining.

On the free cash flow side, yes, it's really a function, again, sitting at around $300 million. High end of the range on our guidance range $270 million, it really comes down to the function of that working capital. The timing of that working capital in our models.

So at the end of the year, primarily driven by that AR side and potentially some of the equipment investments on some of these other usage-based models in the second half. I'm being cautious on that working capital number or that free cash flow number in the second half. So, again, you'll see more details at the Analyst Day.

And on the back office infrastructure side, it's really getting back to those comments Vic made on the sales support side. We need to become more efficient on having our account execs address the business solutions at a customer, not spending time configuring hardware-type sales or product sales and getting that through the system.

Again, this is getting more infrastructure support on the sales side to make them more efficient out in the field. And also upfront, making that support investment for the Cloud business. So, again, that revenue will be ramping up on predominantly the subscription model, the upfront, we call it scaffolding, or the infrastructure around that cloud will be growing in front of that revenue so that we're not mitigating that or adversely impacting that revenue growth trajectory.

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Good stuff. Thank you, Steve.

Victor L. Lund - Teradata Corp.

Last quarter I told you I believed in Teradata and its people. My First Quarter here has only made me more excited about that, as you've heard. Our customers, as I said, they value our technology, our people and the solutions we deliver for them.

The team is charged up. We're fully engaged and we're ready for change. And I look forward to updating you on our progress next quarter and then at the Analyst Meeting. Thank you all so much for joining our call today.


And this concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!