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Teradata Corp (NYSE:TDC)
Q3 2019 Earnings Call
Nov 7, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen thank you for standing by and welcome to the Q3 2019 Teradata Earnings Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today Nobel Elsheshai. Thank you. Please go ahead sir.

Nabil Elsheshai -- Senior Vice President of Finance and Investor Relations

Good afternoon, and welcome to Teradata's 2019 Third Quarter Earnings Call. Vic Lund Teradata's Executive Chairman and Interim CEO will lead our call today followed by Mark Culhane Teradata's CFO. Our discussion today includes forecasts and other information that are considered forward-looking statements. While these statements may 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 be discussing certain non-GAAP financial information which exclude such items as stock-based compensation expense and other special items described in our earnings release including acquisition reorganization-related cost asset impairments and capitalized software development costs.

We will also discuss other non-GAAP items such as free cash flow and constant currency revenue comparisons. A reconciliation of our GAAP results to our non-GAAP results and other information concerning these measures is included in our earnings release which is accessible at investor.teradata.com. A replay of this conference call will be available later today on our website. Teradata assumes no obligation to update or revise the information provided during this conference call whether as a result of new information or future results.

Now I will turn the call over to Vic.

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Good afternoon, everyone. Before Mark discusses our results I want to take a few minutes to talk to you about our recent announcement regarding our CEO change. As you are aware we announced that Oliver has stepped down as CEO. The Board of Directors and Oliver agreed that this was an appropriate time for a change in leadership. Oliver did a fantastic job of defining our strategy and developing our vision centered on customer success, Our strong ARR growth this quarter demonstrates our strategy is working and that our customers are embracing it. However the skills that make a great visionary are not always those that drive great execution. Our Board believes we are at a point in our transformation where strong executional skills are required to continue to drive through a successful completion of our strategy. It is for this reason that the Board decided a change was required at this time. The Board is immediately commencing a CEO search to propel Teradata forward. We have an excellent search committee who will dedicate their efforts to finding the best person they can for this important role. I will not be a candidate but I will support the new CEO through his or her onboarding to ensure that we have a seamless transition, We have the right strategy and vision a solid team committed to our customers' success and market-leading technology innovation all of the right ingredients for us to be successful. As interim CEO I along with the rest of our leadership team will ensure that our eyes are focused on execution and will drive to a successful 2020.

Now I'll turn the time over to Mark.

Mark Culhane -- Chief Financial Officer

Thanks, Vic and good afternoon. I will center my remarks on our financial and business results starting with the news that we're at the high end of our expectations for ARR and guidance for recurring revenue and that Teradata had a strong quarter with customers moving to subscription at a record rate demonstrating our strategy in action. I will start by covering our business update with 3 key takeaways all centered on driving customer success which in turn drive success for Teradata and value for our shareholders. First we continue to move forward in the cloud, We have developed our strategy to position Teradata to lead the market in cloud-based data analytics and we recently announced a major set of capabilities to help companies move from analytics to answers wherever they are on their cloud journey. Second we are continuing to build momentum with Teradata Vantage growing adoption of new and expanded capabilities including machine learning and time series analysis that increase consumption. And third the power of Vantage in the cloud is opening possibilities for us to strengthen our go-to-market. Let's start with our cloud trajectory. We continue to move forward in the cloud by providing our customers choice based on the industry's strongest hybrid and multi-cloud offering. Along those lines we made several important product announcements at our recent user conference.

We announced a new strategic partnership with Google. Our customers can leverage the full power of Vantage across the top 3 global public cloud providers AWS Azure and soon Google Cloud. Only Teradata provides the same functionality in both hybrid and multi-cloud environments giving customers the utmost choice and flexibility. We also announced true consumption or pay-as-you-go pricing giving Vantage customers the freedom to perform complex analytics on virtually any amount of data and to only pay for what is used based on completed queries a true innovation in the industry. This innovation continues our commitment to help customers move to or expand their current Teradata system providing financial and operational flexibility. And we added native support for low-cost storage via Amazon S3 and Azure Blob. Low-cost object storage captures and retains data at a granular level from sources like sensors clickstreams customer service calls social media and more. This addition opens up new use cases to gain value from the power of Vantage analytics thereby expanding our market opportunity. We are increasingly seeing our customers utilize the public cloud. The great value Teradata provides comes from the same powerful analytics insights and answers in the cloud as on-premises. And today I'll provide a few examples. Canal+ Group a leading French TV broadcaster and a long-standing Teradata customer has successfully migrated to Teradata Vantage on AWS to improve the digitization of their customer interactions.

A global home furnishings market leader is becoming a more analytic-driven company with the support of Teradata, This new customer is using machine learning and Vantage running on Azure for advanced analytics. A world-leading car manufacturer based in Japan has selected Teradata as its partner to innovate on its next-generation products and services. By analyzing telematics data with Teradata Vantage on AWS the customer is looking to improve its maintenance quality and gain deep insights into how its cars are being used. Now let's look at the second key takeaway our continued progress with Vantage. We keep raising the bar on Vantage our most successful platform in history. I mentioned earlier that we added Vantage support for low-cost native object store. In addition we launched 2 new products designed for important users: Vantage customer experience which enables marketers to have a 360-degree view of their customers; and Vantage analysts which brings the power of Vantage advanced analytics to business users. Now I'd like to share a few of our recent Vantage customer wins. A global pharma leader selected Teradata to help realize its long-term R&D strategy of reducing time and cost of developing new drugs. With Vantage and its machine learning capabilities the customer will address the challenge of data integration and advanced analytics and help its scientists analyze complex data sets generated from lab machines that deliver better and faster patient outcomes to the market.

With Teradata Vantage running in the public cloud on AWS, we are also supporting the customer's global IT digital transformation journey. A large U.S. retailer chose Teradata Vantage as its advanced analytics platform to provide a 360-degree view of its customers to provide a superior customer experience. Analytics will provide the answers needed to personalize its customers' omni-channel journey while streamlining back-office processes for supply chain and order fulfillment. One of the largest healthcare payers in the world based in the Americas doubles down on Teradata with Vantage consumption. Now one of our largest customers is better suited to focus on business value realization ensuring the value is captured in line with the investment. At a large U.S. outdoor retailer and hospitality group we replaced a competitor to help the customer have an enterprise view of its customers spanning all of its retail and hospitality brands as well as its manufacturing division. We are helping our customer improve the lifetime value of its customers by integrating retail hospitality and warranty transactions. Earlier I mentioned that the capabilities of Vantage are available to customers whether in the cloud or on-premises. And through this functionality we are positioned to go-to-market expansion through new partnerships that can open new markets and new channels.

Just last week we announced a strategic partnership with Deutsche Telekom to bring the power advantage to small and medium enterprises in Germany. This partnership will help customers in this large market take advantage of the enormous potential of best-in-class data analytics, Deutsche Telecom will leverage Vantage to develop and take to market analytics uniquely targeting the SMB segment that Teradata traditionally has not addressed through our direct sales organization. Now I want to spend a few moments on a few key factors driving our financial results including our faster-than-expected transition to our recurring revenue model and the related impact on our reported results and update on our consulting transformation and our updated financial outlook given our faster transition to a subscription-based business plans to accelerate our company execution and consideration of the uncertain IT spending environment. First our go-to-market organization drove a solid quarter exceeding our expectations for incremental ARR growth in Q3. After our go-to-market reorganization earlier this year the team has settled in and we added incremental depth to our sales leadership with new heads of Americas and APAC bringing dozens of years of enterprise sales experience. We are proceeding along our transition to a subscription-based business model at an unprecedented rate. In fact during the quarter one of our largest customers materially increased consumption while moving to subscription for the first time.

As a result for the full year we now expect subscription-based bookings mix to be approximately 90% versus our original expectation of 70% or more. Therefore as of the end of this year we will be substantially through our transition to a subscription-based business model and expect little to no perpetual revenue next year. Consequently next quarter will be the last quarter that we provide a bookings mix metric. The accelerated pace of our transition to subscription obviously has implications for our near-term financial metrics. It results in lower perpetual revenue than we expected coming into the quarter for both Q3 and Q4 as well as the resulting implications that has to our operating income earnings per share and cash flow for our second half results but clearly sets us up for incremental improvement in 2020 and beyond. On the other hand the transformation of our consulting organization is taking longer than we expected and gross margin improvement is trailing our expectations, It is important to understand that certain types of consulting are a very important part of delivering customer success and driving increased consumption of Teradata software. So our priority is to make sure we sustain those capabilities to support our customers.

The transformation of our consulting organization includes 3 key strategic steps: eliminating consulting work that is unrelated to driving incremental consumption of Vantage; simplifying our products in order to automate areas that are currently handled by consulting; and deepening our partnerships with strategic system integrators that are in a strong position to efficiently deliver these services. We made strong progress in refocusing our consulting on Vantage-oriented offerings that will increase consumption while exiting nonstrategic consulting engagements resulting in a 27% decline in consulting revenue in Q3 which was greater than expected. Taken together these items are putting additional pressure on our near-term financial results but are critical to setting up Teradata for strong predictable long-term profitable growth. A faster transition of our business to recurring revenue means that we now expect perpetual revenue to be around $90 million for the year a decline of roughly $215 million from 2018. We now expect our consulting revenues to decline year-over-year by approximately 25% versus prior expectations of roughly 20%. However we are not going to see the corresponding consulting margin improvement in 2019 as we expected though we remain confident in our ability to ultimately increase our consulting margin significantly as we execute on our strategy.

Therefore consulting margins will likely be similar to last year's level for the full year, As a result of all of these items we now expect our full year non-GAAP EPS for 2019 to be approximately $0.95 to $1 and the full year free cash flow to be approximately $85 million to $90 million with the cash used for restructuring actions now being expected at the high end of our prior $60 million to $80 million range. A significant portion of the decline from prior expectations is due to the faster transition to subscription than previously expected while the remainder is primarily a result of slower-than-expected execution against our 2019 operational plan as well as a higher annual tax rate. With these factors in mind and understanding of external data point showing a more mixed overall IT spending environment we are taking a more conservative approach to our outlook for Q4. We are now expecting full year ARR growth of at least 8% reported which includes a point of currency headwind. We expect recurring revenue for Q4 of $348 million to $350 million which results in recurring revenue growth of 8% to 9% for the year or 10% to 11% in constant currency. For this quarter we've put additional financial detail on the IR website providing greater color on key financial metrics. We have made many significant investments in 2019 and remain confident that the company is positioned for significant incremental improvement in 2020 and beyond. As a result we believe 2019 should be the trough in our EPS and free cash flow metrics as we pass the peak of our model transition and we expect substantial improvement in 2020. We will provide more details relating to our expectations for 2020 during our Q4 earnings call and we expect to hold an Analyst Day in the first half next year to provide additional color on our business and an update on our long-term financial targets.

Operator we are now ready to answer questions.

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from the line of Wamsi Mohan from Bank of America.

Wamsi Mohan -- Bank of America -- Analyst

Mark can you elaborate on the Q4 weakness in recurring revenues? Last quarter you had spoken about being comfortable with an acceleration Q3 to Q4. Can you talk about what's changed either from a macro perspective? Was it more macro? Was it more execution-driven? And thoughts on free cash flow please for '19 and '20? And I have a follow-up.

Mark Culhane -- Chief Financial Officer

Thanks Wamsi. So first of all timing has changed a bit from the linearity expectations we had. And secondly we're taking a much more conservative approach to Q4 given the overall uncertainty around the IT spending environment and other uncertainties in our Q4 outlook.

Wamsi Mohan -- Bank of America -- Analyst

And on free cash flow Mark?

Mark Culhane -- Chief Financial Officer

Yes free cash flow is really impacted by the faster move to subscription. There are significantly less perpetual revenue running through this for Q3 and Q4 than we expected and obviously we don't collect that cash. It's going to be collected into the future which gives us the confidence that '19 is the bottom from an EPS and free cash flow perspective.

Wamsi Mohan -- Bank of America -- Analyst

Okay. And if I could Vic the CEO transition has been very quick. It feels almost too quick to judge execution. If you were pleased with the strategy why did the Board decide not to give some incremental time on the CEO transition? Clearly it adds more disruption at a time when you're doing a lot. 3

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Yes. Wamsi thanks. So Board has an obligation to understand when it's time to do something. We -- Oliver a great visionary loved him. He was -- he had never been a CEO before put him in place and watched. I stayed close Board stayed close and we just reached a decision that we had reached a point where we had to be more focused on execution. Oliver is a great visionary. He did a wonderful job but it was the collective decision of the Board that we just needed to drive more concrete execution across the entire organization. So it's -- sometimes the things -- and I said this in my opening comments the thing that makes a great visionary doesn't often make a great executioner. And I just think that in the Board's estimation and I believe I was one of the -- with them that we expected that waiting more time would not result in a benefit for the organization or any different outcome. Oliver is a good friend of mine. He still is a good friend of mine but the truth is what the truth is. And when you realize it it's time to do something about it and that's what the Board did. We have a good Board. Obviously not done on a whim. We watched it for a while. We thought about it. We've had discussions and we just decided it was time. I mean after watching in your judgment you make decisions and that's what we did. Strategy is strong customer reception is good organization is still here but we have to start driving things like consulting and stuff and making those happen to drive better performance. I mean it's simply unacceptable.

Operator

Your next question comes from the line of Katy Huberty from Morgan Stanley.

Katy Huberty -- Morgan Stanley. -- Analyst

Welcome back Vic. A couple of questions just a follow on Wamsi's. The company went through a CEO search several years ago and didn't -- from an external view didn't seem to come up with any good options. Why do you think this time will be different? And then as a follow-up you're going through clearly a pretty tricky business model transition. It creates a lot of volatility in the near term but the end game is a more stable business long term. The market doesn't seem to be giving you credit. And so does the Board think about or why not the idea of doing this in the private market instead or thinking about other strategic alternatives?

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Okay. Right. So I'll try to remember every part and if I don't then you can remind me.

Katy Huberty -- Morgan Stanley. -- Analyst

Okay.

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

So we'll go through that where we are. So first thing a few years ago we actually did not do an internal search -- I mean external search. We went through that process. I came in for a period of time and we decided that there were a lot of just basic blocking and tackling we got through where we got and a year ago we felt like we're getting to stop up. We had good performance in hitting our metrics and everything we want to do. Oliver was great. We knew that Oliver was a new CEO great visionary and we decided from the stability of the company he is well liked by all of us. It would be better for the company if we could work through that and if it worked out it would be great. That would be the best transition for our company. Unfortunately that isn't the way it worked out. So we didn't do the external search at that time. We are highly confident that we can find. The Board is there. We have our committee together and they're starting that process today. And I think we will find a good candidate. One of the advantages I think we have today is we know the characteristics we need in the business now better than we did then.

A strong business but for all of you that have been around a long I mean there is really a major difference between having a feel for driving executional excellence. So one has to have the kind of skills and interest interestingly enough to drive that outcome. And I think we will make sure in this new leader that we have that. As to your last question we think the plans we've got in place here are -- will drive great shareholder value. Our Board is obviously always aware of their fiduciary obligations but the plans we've got in place will drive value. It's good value. I mean everybody talks about this stuff how do you live where you live but I own a lot of stock personally. I've never sold a share and I do not intend to sell a share. I believe that there is a lot of near-term value here. We have been through this. The Street hasn't understood it. And if we can start showing which we will do next year the advantage of both a great strategy and a strong executional program I think then we'll start to get credit. But I am not a believer in PR'ing your way to the top. It takes quarter after quarter of strong performance hitting the goals you like and the metrics that you put in place. And we will see that we do that going forward.

Katy Huberty -- Morgan Stanley. -- Analyst

Just a quick follow-up. Mark you've talked about EPS and free cash flow next year. How would you at this point think about the revenue trajectory now that perpetual has run off and you've resized the consulting business?

Mark Culhane -- Chief Financial Officer

Yes we'll have more to talk about I think on the 2020 outlook when we get on our Q4 call. But again we said I think 2019 is the bottom that we get incremental growth from here across all key metrics.

Operator

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

Raimo Lenschow -- Barclays -- Analyst

I'm slightly puzzled Mark. Maybe you can help me. I get the faster transformation. And so perpetual is running off and professional service is running off. But you're guiding down also recurring ARR which is kind of the stuff that is in a few of the good stuff. So I'm just trying to -- and if I look at the picture from kind of high up it's like with the CEO change it looks like my pipeline for Q4 is kind of slightly emptier than you thought at this point and that's why the guide on is on all levels. But maybe I'm just misreading it. Can you help me kind of put some kind of more color around them?

Mark Culhane -- Chief Financial Officer

Yes. I think what we've said is we are taking a more conservative approach to our Q4 outlook due to the overall uncertainty around the IT spending environment and other uncertainties. And that's really what's driving the guide.

Raimo Lenschow -- Barclays -- Analyst

Yes. And so if I look at the geographic performance can you talk to that a little bit in terms of -- if I look at the numbers in Americas EMEA APAC is there anything you see differently in some of the regions? Or is that kind of...

Mark Culhane -- Chief Financial Officer

No they're all moving to subscription at a fantastic rate. That's why you see the revenues have come down across '19 in all 3 regions yet the segment gross profits are all increasing because it's being driven away from perpetual to subscription where we carry a much more higher gross margin profile. And that's really what is playing out how we thought.

Operator

Your next question comes from the line of Derek Wood from Cowen.

Derek Wood -- Cowen -- Analyst

This is Nick Altmann on for Derek. How long do you guys expect the CEO search to take? And what are some of the qualities you're looking for in the new CEO?

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Well so we are starting -- the committee has identified a search firm they're going to use in the individual there. And we haven't signed anything yet so they don't like you to name that if they have that. We will start interviewing candidates as soon as they can pull it together. My -- and who knows on this right because we're just starting. But my guess is six to eight months. I think you'll get a lot of -- got to get through year-end. People got to collect their bonuses and all that kind of stuff and then they get more ready to be where they are. But I would think likely in six to eight months we should be in good shape and then we'll get a fairly short transition I would think. That's our thought process today. And of course we'll just see where that's at. The qualities we're looking for are we would love someone who has been through a transition before who has good operational experience and can leverage where we're at to strong growth. Further I think the thing that we could really see that we benefit our improvement. We have a very strong team in place now or we're hiring some excellent people. We have a really strong team in place. And the other characteristic this leader has to have is the ability to properly use a seasoned executive team and work through them let it peculate bottoms up as opposed to top down. So you allow your people to do the best they can. And I think the ability of the team to be turn loose and do their capabilities will also increase our operating performance.

Derek Wood -- Cowen -- Analyst

Got it. Okay. And then just given the results in the Q4 guide and the CEO transition how are you guys thinking about your previously issued 2021 framework? Or can you give us a sense as to when you might revisit that?

Mark Culhane -- Chief Financial Officer

Yes. We'll hold an Analyst Day in the first half of next year where we will give more insight on that.

Operator

Your next question comes from the line of Tyler Radke from Citi.

Tyler Radke -- Citi -- Analyst

Maybe a question for Vic. I guess just on the CEO transition one of the things that I had heard from multiple customers with Oliver taking over was just kind of a sense of positivity of having a product visionary at that leadership position. And I think a lot of employees were also inspired by that but just how confident are you that potentially this transition isn't going to dampen the morale among both your employees and customers? And how are you working through what could be kind of viewed as a challenging next few months?

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Well for me personally I've been here before. I know the people they know me. I have spent 2 days in meetings with people. The reception I've had is very positive. I know for sure the field is excited about it most of them not because of an adjustment one way or the other but different management styles and power and cause people to grow differently than they would. And I think they're excited about that. I know a lot of our big customers. I'm with them DT. I know the -- people there. Some of the big deals we did in --. I know those customers. So it is true that Oliver is a great visionary and he brings a lot that's fair. But we have the benefit of his vision in our product today. He is still a friend of mine still a good friend of the company's. And so there won't be any animosity. Customers in the businesses at the end of the day I think love vision but they buy outcomes. And so our job is to make sure all the things we've talked about deliver value to our customers not inspiration for the future. And that's what we're going to focus on in the next year.

Tyler Radke -- Citi -- Analyst

Great. And then just a follow-up. I guess has there been any change on the pricing or packaging with respect to Vantage? And I know one of the topics discussed at the recent user conference was potentially a move toward pay-as-you-go pricing but just curious if that's having any impact on some of the -- on the outlook we're seeing? Or if there's anything to call out from a new product or pricing perspective here?

Mark Culhane -- Chief Financial Officer

No Tyler no. As we said in our prepared remarks we did announce a consumption pricing model at our customer conference that has gotten lots of attention and interest from the customers because it's market-leading you only pay for completed queries which is unique in the industry. So nothing specific there. It'll be actually additive to how we move forward.

Operator

[Operator Instructions] There are no further questions at this time. Mr. Victor Lund I turn the call back over to you.

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Thank you very much. Thank you to all of you for joining our call. I know a lot to digest here. But I want to leave you with our commitment to drive execution make this the bottom of our transition turnaround show strong growth both earnings per share and revenue as we go forward and we demonstrate a continued record of hitting the targets that we have put out in front of you. So I understand we've got something to earn here. We will do that and again thank you so much for being on the call.

Operator

Ladies and gentlemen this concludes today's conference call. Thank you for participating. You may now disconnect.

Duration: 37 minutes

Call participants:

Nabil Elsheshai -- Senior Vice President of Finance and Investor Relations

Victor L. Lund -- Executive Chairman, Interim President and Chief Executive Officer

Mark Culhane -- Chief Financial Officer

Wamsi Mohan -- Bank of America -- Analyst

Katy Huberty -- Morgan Stanley. -- Analyst

Raimo Lenschow -- Barclays -- Analyst

Derek Wood -- Cowen -- Analyst

Tyler Radke -- Citi -- Analyst

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