TERADATA CORP quarterly report, Q2 FY2019

Business Context and Reporting Period

Teradata Corporation is a hybrid-cloud analytics software provider offering software, hardware, consulting, support, and managed services, including its Teradata Vantage platform. The company is transitioning from perpetual software and hardware sales toward subscription-based offerings. This Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.

Effective January 1, 2019, Teradata reorganized its operating segments into the Americas, EMEA, and APAC regions. Prior-period segment information was restated for comparability.

Financial Performance and Key Metrics

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Total revenue	$478 million	$544 million	$946 million	$1,050 million
Recurring revenue	$338 million	$312 million	$669 million	$614 million
Perpetual licenses and hardware	$29 million	$97 million	$60 million	$166 million
Consulting services	$111 million	$135 million	$217 million	$270 million
Gross profit	$236 million	$250 million	$460 million	$473 million
Gross margin	49.4%	46.0%	48.6%	45.0%
Operating income	$10 million	$10 million	$5 million	$6 million
Net income (loss)	$(1) million	$4 million	$(11) million	$(3) million
Diluted EPS	$(0.01)	$0.03	$(0.09)	$(0.02)

Q2 recurring revenue represented 70.7% of total revenue, compared with 57.4% in the prior-year quarter. Annual recurring revenue was $1.35 billion at quarter-end, up 11% year over year, including a 1% foreign-currency headwind. Subscription bookings represented 90% of Q2 bookings; management continued to expect at least 70% for full-year 2019.

Six-month operating expenses were $455 million, compared with $467 million in 2018. Research and development increased to $159 million from $152 million as Teradata invested in Vantage and cloud offerings, while selling, general and administrative expense declined to $296 million from $315 million.

Cash Flow, Liquidity, Debt and Balance Sheet

Six-month cash provided by operating activities was $104 million, down from $290 million in 2018.
Free cash flow, defined by the company as operating cash flow less property and equipment expenditures and capitalized software additions, was $75 million versus $228 million in 2018.
Capital expenditures were $27 million for property and equipment and $2 million for capitalized software.
Financing activities used $154 million, including $175 million of share repurchases and $6 million of long-term debt repayments.
Cash and cash equivalents were $635 million at June 30, 2019, compared with $715 million at December 31, 2018. Cash, cash equivalents, and restricted cash totaled $637 million.
The company had $491 million of total principal debt outstanding: $494 million under the term loan, less current-period repayment presentation effects in the balance sheet. The balance sheet reported $25 million of current debt and $466 million of long-term debt.
No borrowings were outstanding under the $400 million revolving credit facility, leaving $400 million of capacity. Teradata was in compliance with its debt covenants.
The term loan is hedged with an interest-rate swap. The company reported an all-in fixed rate of 4.36% at June 30, 2019.
Operating and finance lease liabilities totaled $150 million at June 30, 2019. Adoption of the new lease standard added approximately $68 million of net lease assets and $66 million of lease liabilities at January 1, 2019.

Management stated that existing cash, operating cash flow, and available credit capacity should be sufficient for working capital, research and development, capital expenditures, pension contributions, and other financing needs for at least the next twelve months.

Material Changes Versus the Prior Comparable Period

Q2 revenue declined 12%; six-month revenue declined 10%. Foreign-currency movements reduced Q2 revenue by approximately 2% and six-month revenue by approximately 3%.
Recurring revenue increased 8% in Q2 and 9% for the first six months, reflecting the shift to subscription-based contracts.
Perpetual software license and hardware revenue fell 70% in Q2 and 64% year to date as customers moved toward subscriptions.
Consulting revenue declined 18% in Q2 and 20% year to date as Teradata realigned its consulting resources toward higher-value engagements and opportunities expected to drive software consumption.
Gross margin improved to 49.4% in Q2 and 48.6% year to date, primarily because of the higher recurring-revenue mix, although subscription transactions generally carry lower margins than legacy maintenance revenue.
Operating income was flat in Q2 and only modestly higher year to date despite lower revenue, supported by cost-management initiatives.
Operating cash flow and free cash flow declined substantially, partly because of restructuring payments, higher variable-compensation payments, and the slower cash collection pattern associated with subscriptions.
Shares outstanding declined to approximately 114.1 million at July 31, 2019. The company repurchased approximately 4.3 million shares for $175 million during the first six months.

Guidance, Outlook, Risks and Unusual Items

Management expects recurring revenue and annual recurring revenue to continue growing as subscription adoption expands, while perpetual revenue is expected to continue declining during 2019.
Consulting revenue and bookings are expected to decline as the company focuses on targeted Megadata customers and higher-margin offerings.
Based on currency rates at July 31, 2019, management expected foreign-currency translation to reduce full-year 2019 projected revenue growth by approximately one to two percentage points.
Management estimated a 2019 full-year effective tax rate of approximately 21%.
A $4 million discrete tax expense related to the Altera uncertain-tax-position matter contributed to the six-month tax expense of $6 million on a pretax loss of $5 million, producing a reported effective tax rate of negative 120%.
The company incurred $12 million of business-transformation and headquarters-transition costs in 2019 and expected total plan costs of approximately $35 million to $40 million, with completion expected in 2019. It also recorded $6 million of accelerated amortization related to the prior headquarters lease during the first six months.
Teradata faces execution risk from its transition to subscription and cloud offerings, including near-term pressure on reported revenue, cash collections, and margins.
Other risks include foreign-currency exposure, interest-rate exposure, reliance on Flex for hardware assembly, potential supplier disruption, customer credit concentration, and the need to maintain positive operating cash flow and debt-covenant compliance.
Teradata is pursuing trade-secret, copyright, and antitrust claims against SAP. In July 2019, SAP filed patent-infringement counterclaims involving five patents. The company stated that the likelihood and potential loss range for the counterclaims could not currently be estimated.
The company reported no litigation that it believed would materially affect its financial condition, results, or cash flows, other than the disclosed SAP matters, and reported no material changes to previously disclosed risk factors.
On July 28, 2019, the board authorized an additional $500 million for share repurchases, bringing total remaining authorization under the general repurchase program to $620 million.

Important Facts for Investors to Verify

Whether recurring revenue and ARR growth can offset the continuing decline in perpetual and consulting revenue.
Whether subscription economics improve margins and cash generation as management expects.
The sustainability of operating cash flow and free cash flow after restructuring payments, lease obligations, debt service, and share repurchases.
The company’s approximately $494 million term-loan balance, 2023 maturity and amortization schedule, interest-rate hedge, and covenant headroom.
The effect of the Altera tax matter and other uncertain tax positions on the full-year tax rate.
The status and potential financial exposure of SAP’s patent counterclaims.
The impact of the new lease accounting standard, headquarters transition, and remaining restructuring obligations.
Regional performance, particularly the significant APAC revenue decline and the continuing foreign-currency headwinds.