Teradata (TDC) Q1 2018 Results - Earnings Call Transcript

Teradata Corp. (NYSE:TDC) Q1 2018 Earnings Call May 3, 2018 5:00 PM ET

Executives

Gregg Swearingen - Teradata Corp.

Victor L. Lund - Teradata Corp.

Oliver Ratzesberger - Teradata Corp.

Mark A. Culhane - Teradata Corp.

Analysts

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Wamsi Mohan - Bank of America Merrill Lynch

Raimo Lenschow - Barclays Capital, Inc.

J. Derrick Wood - Cowen & Company LLC

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Jesse Hulsing - Goldman Sachs & Co. LLC

Philip Winslow - Wells Fargo Securities LLC

Abhey Lamba - Mizuho Securities USA LLC

Operator

Good afternoon. My name is Shauntelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Teradata Q1 2018 Earnings 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.

Gregg Swearingen, VP of Investor Relations, you may begin your conference.

Gregg Swearingen - Teradata Corp.

Good afternoon. And thanks for joining us for our 2018 first quarter earnings call. Victor Lund, Teradata's CEO, will lead our call today. Oliver Ratzesberger, our COO, will then discuss our technology advancements, differentiation and customer activity. Then CFO, Mark Culhane, will discuss our financial results and guidance.

Our discussion today includes forecast 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 differ 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 and other special items described in our earnings release, including acquisition, reorganization, and transformation related costs, asset impairments, and capitalized software development costs.

We may also discuss some of the non-GAAP items such as free cash flow. A reconciliation of our GAAP results to our non-GAAP results and other information concerning these measures is included in our earnings release and on the Investor page of teradata.com. A replay of this conference call will be available later today on that website.

Teradata assumes no obligation to update or revise the information provided during this call, whether as a result of new information or future results.

And now, I'll turn the call over to Vic.

Victor L. Lund - Teradata Corp.

Good afternoon, everyone. I'm very pleased with our strong start to 2018. Our first quarter reported revenue and our non-GAAP EPS were better than expected. Not only were our reported revenues up versus Q1 2017, but on the old perpetual basis, our revenues in Q1 of 2018 exceeded those of Q1 2016, a clear indication that consumption is growing. In addition, more of our bookings mix were subscription-based than we had originally expected, and therefore our Q1 performance was even better than it appears on the surface.

Our strategy is clearly working. Customers are moving to our subscription-based options faster than we expected. This trend is being driven by Teradata Everywhere, our flexible and scalable offering that reduces the risk of our customer's analytic investments. The net result is that our pipeline, ARR, deferred revenue, and backlog are all growing.

I'd like to spend a few minutes on what we are doing to drive these positive results. Fundamentally, today's Teradata is a very different organization than it was two years ago. We have added subscription-based purchasing options, have developed Teradata Everywhere, and are deploying new capabilities of our Teradata Analytics Platform throughout 2018.

We are developing cloud offerings that run on AWS and Azure, in private cloud and on-prem. We have transformed our go-to-market strategy and built a field team that is able to engage with customers and address their needs not only on the technology front, but also and importantly to help them solve their most pressing business problems with market-led analytics.

Further, we have changed our compensation structure and now incentivize our teams to sell subscription. Also, we have built a sales operation organization to assist in the global deployment of best practices. We introduced and instill new rigor in a formal account planning process. Our sales teams now have modern tools like Salesforce.com that help them develop, track and monitor customers. We have changed the skillset at Teradata by combining the people who developed the software that makes Teradata uniquely positioned to drive analytic performance at scale with new talent in areas like cloud and AI.

We recently brought all of our consulting teams into one global organization to drive revenue and support our customers with a goal of bringing us in line with industry benchmarks for sales and profitability. We have also strengthened our leadership team, bringing in an experienced CFO, CRO, CHRO and, in the last quarter, we added a CMO, who will enhance our brand and help us develop a more disciplined approach in delivering our message to the market.

As I've mentioned last quarter, we promoted Oliver to the position of COO to sharpen our focus on all the aspects that touch our customers. The new leadership team is seasoned, driven and committed to successfully completing our transformation. And while we have been adjusting all these levers, we are continuing investments in our infrastructure to enable us to become more efficient as we move forward.

And finally, while driving revenue and customer engagement remain key, there are still multiple areas where we can continue to improve the effectiveness of our cost structure and we will exploit all of those opportunities.

Looking back, we have accomplished a great deal, yet as a team, we know we are still in the early stages of this exciting journey. I would like to thank the entire Teradata team for all their efforts to drive these results. Many folks said we were crazy to take something like this on in a public form. But the team has validated my belief in them and their commitment to succeed.

And with that, I'll turn it over to Oliver.

Oliver Ratzesberger - Teradata Corp.

Good afternoon. Today, I will share why I'm so confident in our future. I'll talk about some of our innovations around our hybrid cloud-based data and analytics that are helping customers drive business outcomes and be on the fastest path to analytics in the cloud.

We at Teradata are very excited because of the enthusiasm and support we are seeing from our customers. This was very visible in our recent Teradata Universe event in EMEA where we saw a 24% increase in customers and prospects and where I had many engaging conversations with executives. I have three key takeaways for you.

First, Teradata is well positioned to take advantage of digital transformation. Second, we are seeing increasing adoption of our hybrid cloud-based analytics. Through our Teradata Everywhere strategy, we offer customers the best path to the cloud. Third, with the power and scale of our advanced analytics, we are seeing companies add new use cases, increase consumption, and grow TCores.

Today, I'll walk through how we have aligned our business to maintain our market-leading position. As the momentum towards digital transformation increases, redefining the way companies build new business models, create operational efficiencies and, ultimately, generate growth, we believe data analytics is the foundation for this digital transformation. Teradata is well positioned to take advantage of this revolution and we're executing to help the world's leading companies achieve high impact business outcomes from analytics at scale.

Companies are recognizing that our production quality advanced analytics, along with our flexible licensing and deployment options are the best for their needs. As a reminder, our Teradata Everywhere strategy has four key tenets: Analyze Anything; Deploy Anywhere; Buy Any Way; and Move Anytime.

Let's take a look at our advantages. Customers can analyze anything through our new Teradata Analytics Platform which integrates with their preferred engines, tools and languages. They can deploy anywhere. With our hybrid cloud offerings, customers can run the same Teradata software on AWS, Azure, Teradata Cloud and on-premises cloud.

Through our flexible pricing options at our IntelliCloud-as-a-service offering, we enable customers to buy any way. And we help customers move anytime; an industry-first that allows them to move their software across deployment options whenever they need on their timeline. Through our affordable software rights, customers can change where they deploy Teradata, taking the risk out of their buying decisions. No other competitor can match these capabilities.

Here's a recent example. A major fintech company committed to Teradata Everywhere in Q1 doubling their TCores and converting to our Buy Any Way subscription licenses. During the analysis, they also looked at cloud media (00:09:49) vendors and found them to be cost prohibitive and unable to scale to meet their needs. A few other examples of customers leveraging Teradata Everywhere through IntelliCloud include: a global CPG company is running Teradata on AWS to optimize their consumer promotions, improve sales planning and enhance supplier contract negotiations.

A very large telco chose Teradata's new on-premises cloud to provide more elastic expansion capabilities to meet unpredictable workloads, improve service levels, and reduce data center costs. And a leading U.S. healthcare organization adopted Teradata to help ensure that its data remain highly reliable and available as the company moves into predictive analytics and machine learning.

This last example illustrates how we are driving new advanced analytics capabilities that help companies increase their internal investment in IoT. As part of our Teradata Analytics Platform, we recently announced 4D Analytics. This advanced functionality is especially relevant in edge computing applications with constantly changing time and location variables. We integrate analytics for where and when, primarily geospatial, temporal and time series data and combine them with operational and customer data, enabling our customers to operationalize IoT.

This new functionality will help lead the IoT revolution and is the foundation of digital transformation. It enables new use cases like making smart cities smarter by analyzing patterns of trains, taxis and cars, traffic lights, restaurant traffic and general citizen movement to provide insights for improving traffic flow. And another use case like optimizing fleet management by studying sensor data from a vehicle fleet, predicting the probability of a breakdown, and proactively addressing and minimizing the business impact.

With the power and scale of our advanced analytics, we are seeing companies increase consumption and TCore as they add new use cases, including a major manufacturer is running factory analytics on Teradata; a leading energy company added supply chain analytics; one of our world's leading interactive entertainment companies is enabling GDPR compliance analytics; a global machinery manufacturer is running predictive maintenance; a large U.S. healthcare company is improving clinical outcomes; and a multinational petrochemical company is improving yield management.

It is also important to note that Teradata continues to garner excellent recognition from industry analytics for both our customer dedication and our technology innovations. We started off the year by being acknowledged as the number one for customer satisfaction in the Forbes Just 100 rankings. We additionally were named a visionary leader in Gartner's Data Management Solutions for Analytics and further attained the highest scores in their Critical Capabilities for Data Management Solutions for Analytics report.

As I turn the call over to Mark, know that we remain fully committed to continue leading the market and helping our customers drive differentiated value from their data and analytics solutions. We are operating with fierce urgency to help the world's leading companies get on the fastest path to the cloud for analytics at scale and are excited to earn the ongoing validation from our customers.

The entire Teradata team is bullish on our new growth strategy and we are in it to win.

Mark.

Mark A. Culhane - Teradata Corp.

Thanks, Oliver, and good afternoon, everyone. We've had a great start to the year and I'm very happy to report better than expected Q1 results not only in terms of total revenue and non-GAAP EPS but even more importantly, we had 62% of our new and add-on bookings shift to subscription, significantly higher than anticipated.

Although Q1 is seasonally a smaller quarter, this provides us the confidence that our full-year 2018 subscription bookings mix will exceed our earlier projection of 40% to 50%. We now expect full-year subscription based bookings to comprise 50% to 60% of our new and add-on bookings mix.

Obviously, a higher mix of subscription also impacts our reported revenue, EPS, and free cash flow for the year. However, customers purchasing Teradata on a subscription basis is clearly a positive trend evidenced by the 11% increase in recurring revenue in the first quarter, which seasonally is our lowest bookings quarter of the year.

As you have seen in our earnings release, we have changed our financial statement disclosure to better align with our new strategy and how we are managing the business. We are now reporting our revenue in the following classifications, recurring revenue which includes revenue from subscription-based transactions and services as well as perpetual license related software upgrade rights and maintenance. Recurring revenue was $302 million in Q1 which increased 11% from Q1 2017.

Perpetual software license and hardware revenue, which is revenue from on-premise perpetual transactions. In Q1,revenue from perpetual software license and hardware was $69 million. This revenue will likely continue to decline year-over-year as our bookings mix shifts more towards subscription, and it is also likely that this revenue will be a greater mix of hardware revenue going forward as a result of the adoption of ASC 606.

And finally, consulting revenue, which was $135 million in Q1 and increased 5% from Q1 2017. At March 31, 2018, our ARR was approximately $1.2 billion, an increase of 11% from the end of Q1 2017, and our backlog was approximately $1.7 billion, an increase of approximately 5% from year-end 2017.

Before I highlight our Q1 results, I want to make it clear that, unless stated otherwise, my comments today reflect Teradata's results on a non-GAAP basis, which excludes items such as stock-based compensation expense and other special items identified in our earnings release.

Total Q1 revenue was $506 million, above our guidance range of $490 million to $500 million. EPS in the first quarter was $0.19, higher than our guidance range of $0.13 to $0.16, and as expected, lower than Q1 2017 due to the shift to subscription-based transactions and investments related to the company's transformation since Q1 of 2017.

Turning to gross margins, recurring revenue gross margin was 73.2% versus 78% in Q1 2017. As expected, the lower margin year-over-year was due to Q1 2018 recurring revenue mix being more subscription-based revenue which carries lower margins than legacy maintenance upgrade rights revenue. We expect our recurring revenue margins to be in the low-70s range for the remaining 2018.

Perpetual software license and hardware revenue gross margin was 40.6% as compared to Q1 2017's 48.9%. As expected, the lower margins are due to the revenue mix being predominantly hardware related which carries lower margins as compared to software. We expect going forward this revenue will be largely hardware related and therefore margins will fluctuate on a quarterly basis depending on the type of hardware deals done and Q2's margin will likely decline from the margin seen Q1 2018.

And consulting revenue gross margin an improved 170 basis points to a negative 3% compared to negative 4.7% in Q1 2017. Seasonally, the first quarter is typically the lowest revenue quarter and a heavy consultant training quarter resulting in the weakest consulting margins during the year. We have invested in our consulting business to drive our business outcome-led strategy. However, this is an area of focus for the company and we expect our consulting margins to exceed comparable 2017 levels, improve from Q1 2018 levels, and for the full year be in positive single-digits.

Overall gross margin was 48.4% in the first quarter versus 51.1% in the first quarter of 2017. We expect Q2 gross margin to slightly decline from our Q1 2018 level.

Turning to operating expenses, selling, general and administrative expense was $142 million in Q1, increasing, as expected, $15 million or 12% from the first quarter of 2017, largely driven by our strategic transformation investments including higher selling expense.

Research and development expense was $68 million, up $3 million or 5% from the first quarter of 2017, driven by continued investment in our cloud offerings as well as our new Teradata Analytics Platforms. Total expenses increased $18 million or 9% in Q1 versus the prior-year period.

As a reminder, during our fourth quarter earnings call, we mentioned that we expected operating expenses to increase by up to $20 million year-over-year in Q1 2018 due to the strategic investments that we have previously discussed.

Operating margin for the quarter was 6.9%, better than expected versus 12% in Q1 2017. We expect operating margin to improve from Q1 2018 levels on a full-year basis. Teradata's non-GAAP tax rate of 25.8% for the first quarter was lower than the 35.1% rate in Q1 2017, as expected due to the recently enacted U.S. tax reform. We expect our full-year tax rate to approximately 20% and fluctuate quarterly depending on pre-tax income levels and the effect of quarterly non-GAAP discrete tax items.

Turning to cash flow. Net cash flow provided by operating activities was $184 million in Q1 2018 compared to $248 million in the first quarter of 2017. As expected, the decrease in cash provided by operating activities was due to higher expense run rate from our prior year strategic transformation investments that began subsequent to Q1 2017, the company's ongoing transition to subscription-based purchasing options, which result in the company collecting cash over time versus all up-front, and the overall timing of cash collections. Our capital expenditures increased $10 million year-over-year, largely due to customers shifting to subscription-based transactions. As a result, free cash flow for the first quarter was $156 million versus the $230 million in Q1 of 2017.

Turning to our balance sheet, we had $939 million of cash as of March 31, 2018. Regarding cash repatriation during Q1, we brought back $300 million, mostly to pay down our revolving credit facility and buy back shares. And we expect to bring back an additional $500 million across the balance of the year. We plan to use a portion of these funds to buy back shares and keep the remainder for general corporate purposes.

During the first quarter, we bought $76 million of Teradata stock or approximately 2.1 million shares. We continue to buy shares during the first part of the second quarter. Year-to-date, we have used $105 million of cash to buy back approximately 2.8 million shares. We currently have $425 million of share repurchase authorization remaining and we'll be opportunistic in repurchasing shares during the remainder of 2018.

Total deferred revenue was $604 million at March 31, 2018, which was $105 million higher than on December 31, 2017 due to increasing subscription-based transactions and the seasonality of our maintenance billings. I would also like to point out that the adoption of ASC 606 on January 1, 2018 reduced deferred revenue by $19 million.

In terms of the ASC 606 impact on our Q1 reported results, there was no significant revenue impact. Also, as expected and included in our guidance assumptions, operating expense was benefited by $5 million as a result of capitalizing sales commissions which were previously expensed in prior periods.

Turning to guidance, as I previously mentioned, we are experiencing increased movement to subscription-based contracts which we now expect to be 50% to 60% of our new and add-on bookings mix, up from our previous assumption of 40% to 50%. As a result, our 2018 full year and second quarter reported revenue, margins, operating profit, EPS, and free cash flow are impacted by the anticipated increase subscription-based bookings. Therefore, we now expect total revenue in 2018 to be approximately $2.15 billion to $2.18 billion and total revenue in Q2 to be approximately $520 million to $530 million.

We expect to continue our strategic investments throughout 2018 and we now expect full year operating expenses to increase by approximately $20 million to $30 million from 2017, $18 million of which was incurred in Q1.

We continue to expect our 2018 full-year non-GAAP effective tax rate to be approximately 20%. We expect our Q2 effective tax rate to be lower than our Q1 rate, but higher than the anticipated full-year rate due to the seasonality of pre-tax earnings and the timing of the tax impact related to discrete items and non-GAAP adjustments.

As a result of these assumptions, including our bookings mix shifting to subscription-based transactions faster than previously expected, we are now estimating our 2018 full-year non-GAAP EPS to be approximately $1.40 to $1.46. This is based upon full-year weighted average shares outstanding of approximately 123 million. And Q2 non-GAAP EPS is expected to be in the $0.17 to $0.19 range based on 122 million weighted average shares outstanding in Q2. In addition, EPS in Q2 will be impacted by lower perpetual revenue margins driven by some large customers purchasing hardware, but subscribing to software.

We now expect our 2018 free cash flow to be approximately $175 million, plus or minus $25 million, as we see an increasing mix of our transactions shifting to subscription. This accelerating mix shift to subscription results in more customers paying us over time versus all upfront and thus reducing our previous assumptions of cash collections, which lowers our free cash flow assumptions in the short term.

Now, I would like to provide you with an update on our full year expectations for the following key metrics. In terms of ARR, we now expect ARR to grow a little more than our original 10% estimate to approximately 11% in 2018.

Recurring revenue, we continue to expect 12% growth in 2018. Bookings mix: we expect approximately 50% to 60% of 2018 new and add-on bookings to be structured as subscription-based transactions. To the extent this mix percentage increases beyond this range, our financial operating results will be negatively impacted. And we continue to expect high-teens TCore growth in 2018 as we continue to see increased consumption of Teradata from new use cases at existing customers and the addition of new customers.

In closing, it's clear our strategy is working as our customers are shifting to our subscription options faster than anticipated. This is extremely positive news for the future of the company despite the short-term impacts to our financial operating results.

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

Question-and-Answer Session

Operator

Your first question comes from Katy Huberty with Morgan Stanley. Your line is open.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Thank you. Good afternoon. A quick question on the quarter then I have a big picture question. Why was the international gross margin so weak this quarter?

Mark A. Culhane - Teradata Corp.

Hi, Katy. This is Mark. The mix of revenue in international, they probably have over 60% of our total consulting revenue. It's much, much larger overseas than it is in the U.S. and obviously consulting margins are much, much lower than the overall margin profile.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Okay. And then, Oliver walked through a number of good examples where you're getting pulled into AI, IoT automation use cases. And I wonder if you can just spend a couple minutes explaining what products that's pulling from Teradata whether you think you have a full portfolio to address and to gain the largest wallet within those type of projects, because that seems like it's a big opportunity going forward.

Oliver Ratzesberger - Teradata Corp.

Yeah. Thanks, Katy. Completely concur. We believe this is a very large opportunity for us going forward. And this is – there's a couple of things coming together from that portfolio. The first thing is the Teradata Everywhere foundation, the fact that we can deploy in multiple deployment forms the various product offerings that we have. And on top of that is really the Teradata Analytics Platform that is bringing together the different engines, the different languages, the different tools. And this is where we hear from C level executives around the world from our customer base that they have really – they have been struggling with complexity, they have been struggling with silos, they have been struggling with one-off technology that is very hard to operationalize, maintain, keep up and running, and operate.

And so, the Teradata Analytics Platform is what is resonating extremely well with the customer base. And I talked a little bit about a recent release about 4D Analytics, which is one step towards that, or the next step towards it, which really brings together this location-based, time-based, version based view of data that allows customers to prepare the data for the algorithms.

AI is only as good as the feature extraction, the data pipelines, the data science pipelines that you can build for the infrastructure. And this is what we feel that we have a very strong product offering. And customers, again as I said, just came back from Universe in EMEA with 24% more customers out there. Every single one of their executives talked about how these capabilities are game changing for their digital transformations that they are going after.

Kathryn Lynn Huberty - Morgan Stanley & Co. LLC

Thank you very much.

Operator

Your next question comes from the line of Wamsi Mohan with Bank of America. Your line is open.

Wamsi Mohan - Bank of America Merrill Lynch

Yes. Thank you. Good afternoon. Can you talk a little bit about the linearity this year? You have just under 50% of revenues in the first half, but only 26% of EPS. Sounds like you have some larger hardware transactions in Q2 which could put some pressure on margins that might reverse. But what else changes in the back half of this year for profitability?

Mark A. Culhane - Teradata Corp.

Yeah. Hi, Wamsi. This is Mark. So, you're right. I mean Q1 has always been our lowest revenue quarter. Q4 has been our highest revenue quarter. Q4 is our highest revenue consulting quarter, so we see nice margin profile on the consulting in Q4. And if you look at what it's been historically even across 2017, it was in the low-double-digits in Q4 of 2017.

Yes, we have some transactions that are largely hardware relating to that are putting pressure in there. But from an EPS perspective, the back half particularly Q4 has always been the largest EPS quarter, certainly was across 2017 and we expect that again in 2018. But yeah, we see the back half moving on the EPS side much more dramatically than the first half.

Wamsi Mohan - Bank of America Merrill Lynch

Okay. Thanks Mark. And your revenue guide for recurring revenue is still at 12% but you're moving faster to subscription as you alluded to. So can you talk about what is happening at your customers from a maintenance perspective which is probably the offset? And just if I could, a little surprised to see the gross margin profile on the consulting business. Is there anything that is changing for you as a company in a particular fashion? Maybe it's incremental training or whatever it might be that is not allowing you to benchmark appropriately even for the full year at that mid-single digit or high-single-digit margins.

Mark A. Culhane - Teradata Corp.

Yeah. So on the recurring revenue guide, first, we're only through one quarter and we had a great quarter and a great shift in subscription and I'm continuing to expect that to happen which is why I haven't moved that off to 12% at this point in time. Yes, we are seeing shifts from maintenance and upgrade rights to subscriptions. We're seeing uplifts when that happens and so forth. And so obviously, we take a look at that across the balance of the year and we'll determine whether or not how that impacts overall recurring revenue growth.

But clearly within recurring revenue, our subscription-based revenue is growing in excess of 100% and more than doubling year-over-year which is what we expect and we continue to see that happen. So that's happening sort of on that front. What was the second part of that question?

Wamsi Mohan - Bank of America Merrill Lynch

Just on the consulting gross margin profile.

Mark A. Culhane - Teradata Corp.

Yeah. Well, so if you look across what happened in 2017, they were negative in Q1, they became slightly positive in Q2, a bit more positive in Q3, low double-digits in Q4. And I said in my prepared remarks, we expect that same phenomenon to happen. I expect quarter-over-quarter across the balance of the year we will see our consulting margins exceed 2017 levels both on a quarter basis and a full year basis.

The change has been we've now had our consulting organization. It's one organization where in the past it wasn't. It's all managed and organized. We brought that together. That's creating some efficiencies.

And as I said on the call, this is a big area of focus for us going forward because historically we've seen those margins be much, much higher in the past and we're going to, over the transformation over the next couple of years, get them back to that level. Big area of opportunity for us, we believe.

Wamsi Mohan - Bank of America Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Raimo Lenschow with Barclays. Your line is open.

Raimo Lenschow - Barclays Capital, Inc.

Thank you for taking my question. Question for Oliver. Oliver, can you talk a little bit about the competitive environment if you go and sell Teradata now in the new fashion as a subscription model that is kind of more looking at the cloud as well in deployment anywhere. Is that kind of predominantly kind of the old guys, is it kind of the new guys like Snowflake, are you competing with the Redshifts of this world, just help us understand this a little bit better. Thank you.

Oliver Ratzesberger - Teradata Corp.

Yeah, Raimo, thanks for the question. Of course, there is competition in our market right and we have seen competition over the years. And as you said, it was Redshift a few years ago that was predicted to be the big competitor and there's other names like Snowflake that are going around today making a lot of noise. Here is something really interesting. Our strategy is really to focus on the largest analytical opportunities out there, the top 500, as we talked about, right.

And Teradata Everywhere is resonating extremely well with them, why is that the case? Well those are customers that operate at the largest end of the scale, right? They have petabytes of information, they have thousands of users and applications, they expect from their analytics platforms to do it all at the largest scale with the biggest amount of complexity and so forth.

The competitors that we see out there, and while they are very, very noisy, they are good at small siloed deployments. Yeah, they can bring up a data mark for a small department, but they really struggle to scale beyond that. And that is now becoming visible, yet again, in our customer base. Those customers that have tested and tried some of these new capabilities are validating that at scale they are not working.

I told you about a large fintech company that doubled down Teradata investment in Q1, doubled their TCores with us, went completely to subscription. They have tested both Redshift and Snowflake and they told us it became cost prohibitive and impossible to scale to go onto these platforms.

And so, yes, yes we see this, yes we hear that. This is why we believe we are differentiated the most. And for those customers in the top 500, hybrid cloud is a big deal. They need to be able to say, I move some workloads into the public cloud, I use some workloads into the private cloud and they're all – they're moving some workloads into their private data centers. And so you need a solution that runs unchanged in all of these environments. That's the other side of some of these competitors. They are either cloud only or one cloud only and that really limits the applicability for most of the use cases that we're seeing in our customer base.

Raimo Lenschow - Barclays Capital, Inc.

Perfect. A quick follow-up for Mark. Just can you define – how you define ARR, Mark? Thank you.

Mark A. Culhane - Teradata Corp.

ARR is annual recurring revenue. It's a combination of our subscription business and the historical perpetual license maintenance upgrade business.

Raimo Lenschow - Barclays Capital, Inc.

And do you calculate it as – how do you calculate it? Do you take like last quarter's and then multiply it by four or is it including forward-looking numbers?

Mark A. Culhane - Teradata Corp.

No, no. It's in forward-looking. That's the next 12 months. That's an annual recurring revenue run rate. It's not a backwards 12 months. It's a forward 12 months.

Raimo Lenschow - Barclays Capital, Inc.

Okay. Perfect. Thank you.

Operator

Your next question comes from Derrick Wood with Cowen & Company. Your line is open.

J. Derrick Wood - Cowen & Company LLC

Great. Thanks. And Mark, thanks for all those numbers and color. It's nice to get some more granularity. Real quick, on the last quarter, you talked about pipeline up 2x. I don't know if you'll be updating that regularly, but any commentary on how it looks today versus three months ago? And any other color on the pipeline, especially since you had a lot of new field executives you brought in?

Victor L. Lund - Teradata Corp.

Yeah. This is Vic. Pipeline is up again from where it was before, it continues to grow. And so, we feel good about it. New opportunities coming. And so, we feel just as strong about our pipeline now as we did last quarter.

J. Derrick Wood - Cowen & Company LLC

Okay. And kind of a higher level question. I mean one thing we're hearing – I know you guys have talked about this in the past, but customers have wanted the cloud optionality in the database world. But even if they're not really ready to move their database infrastructure to the cloud.

So, I guess, first, is there a way to measure quantitatively or qualitatively how having that option for cloud has improved your ability to get budget approval or budget approval cycles? And second, has public cloud gained a whole lot of adoption at this point or can you give us a sense for, in that subscription line, what the mix looks like between term, hosted and public cloud?

Oliver Ratzesberger - Teradata Corp.

Yeah. So what you're talking about is the core of Teradata Everywhere. And it first started out last year when we first shared that really with customers where they were very positive about the fact that, oh, I have optionality; I have choice. As you say, they might not be ready to move everything into one particular cloud, but they want to know that wherever they go, they can move any time to any other deployment form. And so, it helps executives and companies around the world to really de-risk their buying decisions.

And it has become very obvious as more and more customers were adopting that and the success stories are coming out how easy it was for them to shift from on-premise to managed cloud in public cloud. And to be able to do that in 70 days as we had one example that we shared with you for very large-scale deployments without rewriting a single line of code for the applications that were originally written for the on-premise world.

That is a lot of – getting us a lot of momentum with executives in the conversations that we are having with them. And it's really helping us together with the new bundled pricing and subscription pricing with the choice of where you can deploy, but also the ability to move at any time without having to relicense, that all comes together. And again, if you apply that to the top 500, and if you apply that to our core customer segments, that is what is driving the positive customer momentum that we're seeing. The feedback has been absolutely great from the customer base on that.

J. Derrick Wood - Cowen & Company LLC

Okay. All right, thanks.

Operator

Your next question comes from Karl Keirstead with Deutsche Bank. Your line is open.

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Thanks. A question for you, Mark. Mark, it looks like you reclassified a fair amount of consulting revenues into your recurring bucket. So, I've got two questions there. First, just from a definition standpoint, what were the consulting services that sort of moved over and that were, in your definition, more recurring, because most people think of consulting as frankly being non-recurring? And then secondly, the piece that moved over into the recurring bucket, did it have any different growth or margin profile than the segment that is currently retained in the consulting bucket? Thanks so much.

Mark A. Culhane - Teradata Corp.

Yeah. So, what got moved over is our managed services. Those are all sold on subscription predominantly, so that's all under subscription contracts that renew. So that's a recurring item and that's why it's sitting in the recurring bucket.

The growth profile of that has been largely – pretty small, it's been pretty flat. So that's not what's helping drive any recurring revenue growth at all. It's all the subscription that's driving the recurring revenue growth. That's pretty flat. It does have some differentiated margin profile. Obviously, the managed services margin on that, given their subscription and largely fixed fee have a higher profile than standalone consulting margin.

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Got it. Okay. That's very helpful. Thank you. And then if I could ask one follow-up, just on the pure subscription revenues. I know you haven't disclosed it in the past, but if I remember correctly, I think you suggested on the last call that you think the subscription revenue growth could be north of 100% in 2018. So I just wanted to just recheck on that guidance. Do you still feel comfortable with that, assuming I had that number correct?

Mark A. Culhane - Teradata Corp.

Yes, we do.

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Okay.

Mark A. Culhane - Teradata Corp.

Grow in excess of 100% and more than double in 2018 over 2017.

Karl E. Keirstead - Deutsche Bank Securities, Inc.

Got it. Thank you.

Operator

Your next question comes from Jesse Hulsing with Goldman Sachs. Your line is open.

Jesse Hulsing - Goldman Sachs & Co. LLC

Yeah. Thank you. On the recurring margins or gross margins, I should say, they ticked down year-over-year. And I'm just wondering where you think those can go as you go through this transition and, I guess, scale up that revenue base. I'm curious your thoughts on the full-year 2018, but also I guess over the medium-term and long-term, where do you think those margins can go?

Mark A. Culhane - Teradata Corp.

Yeah. So the recurring revenue down year-over-year is a mix. It's obviously more subscription-based revenue versus a perpetual license legacy maintenance upgrade. And those have different margin profiles. So that's what you're seeing and you'll see across 2017 that they declined across 2017 as more of that subscription revenue came into the recurring revenue line. Over time, we expect these to grow from the low 70s that we expect across the balance of 2018 and approach closer to 80%, which we think is best-in-class in the subscription world when you start to – I mean, they're very good candidly in the low 70s compared to a lot of the other SaaS companies out there and so forth. But yeah, we expect to drive them even higher than from the low-70s going forward.

Jesse Hulsing - Goldman Sachs & Co. LLC

Got you. And Mark, just so I am looking at the right numbers and doing the right math. When you say recurring revenue growth of 12% which is also what you guided to on the fourth quarter call, is that on last year's reported ASC 605 numbers or on the ASC 606 numbers? I'm not totally sure.

Mark A. Culhane - Teradata Corp.

Well it's on – the 2018 numbers are ASC 606, we did not recast the comparable 2017 numbers to go back to ASC 605. So the 12% on that basis, the ASC 606 adoption was a headwind to our recurring revenue growth across the year as compared to the prior year.

Jesse Hulsing - Goldman Sachs & Co. LLC

The guidance is on your ASC 606 (00:47:55).

Mark A. Culhane - Teradata Corp.

Yeah. All our guidance is on a ASC 606 basis.

Jesse Hulsing - Goldman Sachs & Co. LLC

Okay. Got you. Thank you.

Operator

Your next question comes from Phil Winslow with Wells Fargo Your line is open.

Philip Winslow - Wells Fargo Securities LLC

Great. Thanks, guys, for taking my question. As Vic mentioned earlier, when I do the back of the envelope math to sort of with your recurring portion versus last year, it did seem that we see a pretty solid uptick in just product growth, just for that perpetual – that ratable mix year-over-year.

I remember Q1 being a particularly good quarter last year. You talked about it and it essentially like a tough comp here in Q1 because of a large deal. But what are you – coming sort of what drove that year-over-year strength there in Q1, particularly in the context of that tough comp? Was it big deals again, was it just sort of just buying the (00:48:43) business across customers, just sort of what's driving that up that tough comp?

Victor L. Lund - Teradata Corp.

So a little bit of everything, but I guess the big thing and I – we saw versus last year an uptick in international. We were surprised at how quickly international jumped on board this year. We quite honestly expected for that to be a little slower, that's what happened last year and it accelerated significantly in Q1. So that would be the number one factor that caused that percentage to increase and be better than last year.

Philip Winslow - Wells Fargo Securities LLC

Great. And then just one quick follow-up to that, just the pricing environment that you're seeing in Q1 and kind of how you're thinking about that in Q2 and beyond relative to just sort of what you were seeing last year.

Victor L. Lund - Teradata Corp.

So, we're putting discipline. We've talked about discipline in the field and where we are at. And we are not giving product away or anything like that. We are holding our price line. When you go through the deals with the big customers we got, sometimes they're very complicated, how you get it all done and get them to a subscription base and that can create some issues. But in terms of pure pricing, we're holding strong with where we are. We believe in what we've got. I've told our team they got to have swagger, they got to believe in what they sell and it's worth our offering. And so we are holding where we're at. We aren't feeling any pressure.

And in fact, we continue to not try to close deals at quarter-end to get a deal done. First of all, it doesn't matter that much under a subscription basis. But secondly, we don't need to do that. So we have a product which is fairly priced and we think we're treating our customers fair and we expect a fair return. So pricing pressure is not anything that I'm overly worried about.

Philip Winslow - Wells Fargo Securities LLC

Great. Thanks, guys.

Operator

We have time for one more question. Your next question comes from the line of Abhey Lamba with Mizuho Securities. Your line is open.

Abhey Lamba - Mizuho Securities USA LLC

Yeah. Thank you. Mark, this is the first time we're getting the revenue breakdown the way it is. Can you talk a little bit about what's in the recurring bucket different – relative size of each of them? And how should we think about their respective growth rates? And is it also safe to assume that incremental gross margin on some of those recurring buckets is going to be pretty high, in the high-90s?

Mark A. Culhane - Teradata Corp.

Well, so, yeah, we've shifted to a recurring revenue presentation, perpetual hardware presentation and consulting presentation. So within the recurring revenue bucket, yes, we expect those margins over time to improve based on comments I made to Jesse's question that we expect those to improve from the low 70s going forward. Clearly, maintenance software upgrade rights have a blended margin profile that's higher. Clearly, you got software and hardware in those numbers but in software's high 90s and hardware's lower than that, right? But over time, as this shifts and moves to subscription, we see margin improvement moving higher. And so we fully expect to see that a bit across 2018 but clearly more as we get into 2019 and 2020 as we complete the movement away from perpetual.

Abhey Lamba - Mizuho Securities USA LLC

Got it. And Oliver, if I can ask one last one, can you talk about the competitive landscape in terms of adoption of Hadoop for ETL workloads? At some point in the past, you had quantified a potential range of your workloads that could be at risk of migration away to Hadoop. Any color on that in terms of what you're seeing currently in the market would be helpful.

Oliver Ratzesberger - Teradata Corp.

Yeah, absolutely. And I've been quite outspoken that we have used Hadoop as a tool for the right use cases before. What we're seeing particularly over the last year and I think the whole industry is seeing is that Hadoop use cases are actually shifting quite a bit to cloud-based architectures. And this is really intersecting very well with what we are doing with Teradata Everywhere and our focus on cloud deployments. We're seeing very few Hadoop installations move into the cloud.

The vast majority of adoption in the cloud is on cloud native architectures, S3 and EC2 and all other technologies that the cloud vendors offer that. And this is what we really have focused over the last couple of years with Teradata Everywhere as we are rolling out. So, there's a very nice intersection that we're seeing there that's coming together. We expect Hadoop to be a tool out there. We expect it to be used in customers around the world, but we certainly don't see a lot of workloads moving off of Teradata to it.

Abhey Lamba - Mizuho Securities USA LLC

Thank you.

Oliver Ratzesberger - Teradata Corp.

You're very welcome.

Operator

There are no further questions at this time. I will now turn the call back over to Mr. Lund.

Victor L. Lund - Teradata Corp.

Thank you, everyone, for joining us today. I think you've all sensed the enthusiasm that we have about where we are today and our future and where we're going. I'm personally enthused by not only there (00:54:07), but all the areas that we still have opportunity to improve our operation in.

You've talked about some of them, consulting and driving to a better operated company and those are what our infrastructure investment is around. All in all, very, very positive about where we're going, good trends, confident for the year.

We are going to be hosting an Analyst Day here in San Diego sometime in Q4 and updating you on our outlook, as we are getting some more clarity around conversion rates and where we are headed as a company. So, we will be able to provide you a little longer view at that time, and we will get those dates to you.

Again, thank you very much for joining us today, and we look forward to our call at the end of Q2.

Operator

This concludes today's conference call. You may now disconnect.