Teradata Corporation 2017 Q3 Form 10-Q Summary
Business context and reporting period
Teradata provides data and analytics technology, cloud offerings, software, hardware, consulting, and maintenance services. The filing covers the unaudited three and nine months ended September 30, 2017, compared with the same periods in 2016. Following the July 2016 sale of its marketing applications business, Teradata reports Americas and International Data and Analytics segments.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total revenue | $526 million | $552 million | $1,530 million | $1,696 million |
| Product and cloud revenue | $172 million | $210 million | $504 million | $661 million |
| Service revenue | $354 million | $342 million | $1,026 million | $1,035 million |
| Gross profit | $250 million | $294 million | $716 million | $873 million |
| Gross margin | 47.5% | 53.3% | 46.8% | 51.5% |
| Operating income | $7 million | $89 million | $5 million | $134 million |
| Net income | $13 million | $49 million | $7 million | $67 million |
| Diluted EPS | $0.10 | $0.37 | $0.05 | $0.51 |
| Operating cash flow | Not separately provided | Not separately provided | $301 million | $394 million |
| Free cash flow | Not separately provided | Not separately provided | $235 million | $308 million |
- Recurring revenue was $267 million in Q3, or 51% of total revenue, up 8% from $247 million, or 45%, in the prior-year quarter.
- Q3 operating expenses were $243 million, or 46.2% of revenue, versus $205 million, or 37.1%, in the prior-year quarter. Research and development expense increased to $82 million from $46 million.
- Cash and cash equivalents were $1.025 billion at September 30, 2017, compared with $974 million at December 31, 2016.
- Total current liabilities were $936 million, including $180 million of short-term borrowings and $53 million of current long-term debt. Long-term debt was $493 million.
- Teradata had $180 million outstanding under its $400 million revolving credit facility, leaving $220 million available. The company reported compliance with all covenants.
Material changes versus the prior comparable period
- Q3 revenue declined 5%; product and cloud revenue fell 18%, while service revenue increased 4%. For the first nine months, revenue declined 10%, including the effect of the 2016 marketing applications divestiture.
- Revenue mix continued shifting from perpetual licenses and hardware toward cloud, subscription, rental, usage-based offerings, and other recurring revenue. Recurring revenue increased, but the transition reduced near-term reported revenue because recognition is spread over multiple periods.
- Gross margin declined by 580 basis points in Q3 and 470 basis points for the nine-month period. Factors included product and deal mix, higher support and parts costs, consulting investments, lower utilization, and costs incurred before related consulting revenue is recognized.
- Operating income fell sharply because of lower gross profit and increased investment in cloud, strategic initiatives, demand creation, and research and development. Teradata also stopped capitalizing certain software development costs; no R&D costs were capitalized in Q3 2017 versus $16 million in Q3 2016 and $49 million in the first nine months of 2016.
- Operating cash flow decreased $93 million to $301 million, and free cash flow decreased $73 million to $235 million. The company repurchased 11.5 million shares for $351 million during the first nine months.
- The prior-year nine-month period included $80 million of impairment charges and $69 million of marketing applications revenue; neither was present in the 2017 period.
Guidance, outlook, risks, contingencies, and unusual items
- Management estimated a full-year 2017 effective tax rate of approximately negative 7%, influenced by a $6 million discrete tax benefit from the reversal of uncertain tax positions. The nine-month effective tax rate was negative 600% because of the low pretax income and discrete benefit.
- Management expected 2017 recurring revenue growth in the high single digits, recurring product revenue growth above 10%, Business Consulting revenue growth of approximately 20%, perpetual equivalent contract value of approximately $225 million to $250 million, total ARR of $1.1 billion, total ARR growth above 10%, product ARR growth of approximately 25%, and TCore growth in the high teens.
- Management expected reported revenue to remain pressured in the near term as customers migrate from upfront perpetual licenses to subscription and cloud models, with longer-term growth expected as recurring revenue scales. It also expected the subscription transition to materially affect fourth-quarter 2017 revenue.
- Teradata continued an internal investigation and voluntary cooperation with the SEC and DOJ regarding questionable travel, gift, and other expenditures at a Turkish subsidiary. Management did not currently expect a material adverse effect, but stated that the ultimate resolution cannot be predicted and could involve fines, penalties, disgorgement, or injunctive relief.
- The company had approximately $1.0 billion of cash held outside the United States and had not provided U.S. federal tax on approximately $1.4 billion of foreign earnings considered permanently reinvested abroad.
- Other risks include competition and alternative technologies, customer adoption of cloud and lower-cost solutions, foreign currency exposure, customer credit risk, reliance on Flextronics and certain preferred suppliers, and execution risk related to the business transformation.
- Teradata planned to adopt the new revenue recognition standard on January 1, 2018 using the modified retrospective method. The filing states that the impact was still being evaluated and could affect revenue timing, retained earnings, contract acquisition costs, systems, and controls.
Important facts for investors to verify
- Whether recurring revenue, ARR, product ARR, and TCore growth met or exceeded management’s stated 2017 targets.
- The extent to which subscription and cloud adoption continues to suppress reported revenue while increasing recurring revenue and future contract value.
- Whether gross margin and service utilization recover as consulting and cloud investments mature.
- The final impact of the January 2018 revenue recognition adoption, including any opening retained-earnings adjustment.
- The status and financial consequences of the SEC and DOJ investigation concerning the Turkish subsidiary.
- Liquidity after continued share repurchases, debt repayments, workforce optimization payments, and any additional borrowing under the revolving credit facility.
- The concentration of cash outside the United States and potential tax consequences of repatriation.