Business Context and Reporting Period
Teradata Corporation, a hybrid cloud data and analytics software platform provider, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2020. The company provides cloud and on-premises software, hardware, consulting, maintenance, subscription offerings, and managed services through its Americas, EMEA, and APJ segments.
Teradata continued shifting from perpetual software and hardware transactions toward subscription-based offerings and pursuing a cloud-first transformation centered on its Teradata Vantage platform. COVID-19 affected customer transactions, collections, consulting activity, supply-chain conditions, and foreign currency rates.
Financial Highlights
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Total revenue | $454 million | $459 million | $1.345 billion | $1.405 billion |
| Recurring revenue | $365 million | $343 million | $1.068 billion | $1.012 billion |
| Perpetual software licenses and hardware | $17 million | $16 million | $48 million | $76 million |
| Consulting services | $72 million | $100 million | $229 million | $317 million |
| Gross profit | $254 million | $247 million | $735 million | $707 million |
| Gross margin | 55.9% | 53.8% | 54.6% | 50.3% |
| Income from operations | $1 million | $10 million | $3 million | $15 million |
| Net income (loss) | $(1) million | $10 million | $124 million | $(1) million |
| Diluted EPS | $(0.01) | $0.09 | $1.12 | $(0.01) |
Q3 recurring revenue increased 6% and represented 80.4% of total revenue, compared with 74.7% in the prior-year quarter. Total revenue declined 1%, while consulting revenue fell 28%. Nine-month revenue declined 4%, with recurring revenue up 6%, perpetual software and hardware revenue down 37%, and consulting revenue down 28%.
Operating expenses increased 7% in Q3 to $253 million, primarily due to voluntary separation program costs, cloud-transformation investments, equity compensation, and additional go-to-market and customer-success spending. Nine-month operating expenses increased to $732 million from $692 million.
The nine-month net income benefit was substantially affected by income taxes. Teradata recorded a $151 million tax benefit on a $27 million pretax loss, including a significant discrete benefit related primarily to an intra-entity transfer of intellectual property to an Irish subsidiary. The resulting nine-month effective tax rate was 559.3%; management estimated a full-year 2020 effective tax rate of approximately 279%.
Cash Flow, Liquidity, Debt, and Capital Allocation
- Cash provided by operating activities was $211 million for the first nine months of 2020, versus $94 million in the prior-year period.
- Free cash flow, defined by management as operating cash flow less property and equipment expenditures and capitalized software additions, was $171 million versus $48 million.
- Capital expenditures were $34 million for property and equipment and $6 million for capitalized software.
- Cash and cash equivalents were $533 million at September 30, 2020, compared with $494 million at December 31, 2019. Including restricted cash, total cash was $534 million.
- Total debt consisted of $38 million current debt and $423 million long-term debt. The term loan principal outstanding was $463 million.
- The company had no borrowings under its $400 million revolving credit facility, leaving the full facility available, and was in compliance with its debt covenants.
- Teradata repurchased $75 million of common stock during the first nine months, or approximately 3.7 million shares. Repurchases were suspended in the second quarter as a precautionary response to COVID-19 uncertainty; $432 million remained available under the general repurchase authorization at September 30.
Material Changes and Operating Trends
- Annual recurring revenue was $1.501 billion at quarter-end, up 8% year over year, including a 1% favorable foreign currency effect.
- Backlog was $2.577 billion, up 1% year over year. Approximately $1.772 billion was subject to customer-only cancellation-for-convenience provisions; only approximately $322 million was expected to be recognized over the next year from non-cancelable contracts.
- Gross margin improved due primarily to the higher recurring-revenue mix, although subscription transactions generally carry lower margins than legacy maintenance and upgrade-rights revenue because of the hardware component.
- Segment revenue changes in Q3 were Americas up 2%, EMEA down 3%, and APJ down 8%. Segment gross margins improved in all three regions.
- Deferred revenue totaled $520 million at September 30, 2020, compared with $533 million at year-end 2019. Accounts receivable declined to $321 million from $398 million, and inventories declined to $14 million from $31 million.
- Stockholders’ equity increased to $384 million from $262 million at December 31, 2019, primarily reflecting year-to-date net income and equity compensation, partly offset by share repurchases and accumulated other comprehensive losses.
Guidance, Outlook, Risks, and Unusual Items
Management expected 2020 annual recurring revenue and recurring revenue to grow, while total revenue was expected to decline because of the transition away from perpetual transactions and lower consulting revenue. Management expected perpetual revenue to continue declining and consulting revenue to remain affected by COVID-19, customer project delays or cancellations, and the strategic reduction of lower-priority consulting work. Consulting gross margin was expected to be in the low single digits for the year.
In September 2020, Teradata accrued $27 million for a voluntary separation program and estimated total program costs of approximately $32 million, with most actions expected to be completed in the fourth quarter. On November 2, 2020, the company approved a separate workforce-reduction and real-estate-rationalization plan. Estimated costs were $70 million to $80 million, estimated cash expenditures were $75 million to $85 million, and expected ongoing annual cost savings were $80 million to $90 million before reinvestment. The actions were expected to be completed in 2021, with most costs recorded in 2020.
Management believed operating cash flow, cash on hand, and available revolver capacity were sufficient for at least the next 12 months. Key risks included the duration and severity of COVID-19, customer spending and collections, consulting delays, remote-work productivity, foreign currency volatility, supply-chain disruption, reliance on Flex for hardware assembly, execution of the cloud and subscription transition, and the ability to realize restructuring savings.
Teradata was pursuing litigation against SAP involving alleged trade-secret misappropriation, anticompetitive conduct, and patent infringement. SAP asserted patent infringement counterclaims; the filing stated that the likelihood and potential loss range for those counterclaims could not reasonably be determined.
Investor Verification Checklist
- Verify the sustainability and quality of ARR and recurring-revenue growth as subscription revenue replaces upfront perpetual revenue.
- Reconcile reported earnings to operating performance excluding the unusually large discrete tax benefit and assess future cash-tax implications.
- Track consulting revenue, consulting margins, and the continuing effects of COVID-19 on customer projects.
- Monitor execution, cash costs, and savings realization from the voluntary separation, workforce-reduction, and real-estate plans.
- Review debt amortization, the $463 million term loan, interest-rate exposure, covenant compliance, and available revolver capacity.
- Assess backlog conversion and cancellation exposure, particularly the $1.772 billion subject to customer-only cancellation provisions.
- Follow the SAP litigation and any potential financial or operational effects, noting that counterclaim exposure was not estimable at filing.