TDC

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2007, for Teradata Corporation. The filing marks the company's first quarter as an independent, publicly traded entity following its separation from NCR Corporation on September 30, 2007. Prior to this date, Teradata operated as a business unit of NCR, with financial results reflecting allocated corporate expenses and centralized cash management. The separation involved the distribution of 180.7 million shares of Teradata common stock to NCR shareholders.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Consolidated revenue increased 17% in Q3 2007 and 12% for the nine-month period, driven by double-digit growth in all geographic regions (Americas, EMEA, APJ). Product revenue grew 19% in Q3, while service revenue grew 15%.
• Profitability Impact: Despite revenue growth, Net Income decreased 33% in Q3 ($29M vs. $43M) and 12% for the nine months ($115M vs. $130M). This decline was primarily due to $15 million in non-recurring separation costs and a higher effective tax rate.
• Margin Compression: Gross margin decreased slightly (0.9% in Q3) due to a "deal mix" shift toward lower-margin hardware transactions and third-party products. Operating expenses increased due to separation costs and higher demand creation spending ($9M increase in Q3).
• Liquidity Shift: Cash and cash equivalents rose to $196 million at period end, reflecting a $196 million cash contribution from NCR immediately prior to the separation. Prior to this, Teradata had no separate cash accounts.
• Pension Obligations: The company assumed net pension liabilities of $36 million and postemployment liabilities of $50 million upon separation. Pension expense decreased significantly compared to the prior year due to NCR freezing its U.S. defined benefit plans.

Guidance, Outlook, and Risks

• Outlook: Management expects continued revenue growth in 2007 versus 2006, driven by increasing data volumes and real-time analytics demand. Competitive and technological pricing trends are expected to remain consistent with 2005-2006 levels.
• Tax Rate: The effective tax rate for Q3 was 56.1% (vs. 36.8% prior year) due to a $10 million discrete charge for a German tax rate change and non-deductible separation costs. Management targets a long-term effective tax rate of approximately 30%.
• Legal Proceedings: The U.S. Department of Justice is investigating the propriety of certain federal contracts and pricing disclosures. The company has recorded a $1 million reserve but notes outcomes are unpredictable.
• IRS Ruling: A favorable IRS ruling was received regarding the deductibility of capitalized R&D costs, allowing the company to recognize a deferred tax asset that was previously uncertain. However, final written confirmation is pending.
• Market Risk: The company is exposed to foreign currency fluctuations (Euro, British Pound, Yen) and uses forward contracts to hedge transactional exposures. A 10% appreciation of the USD would increase the fair value of the hedge portfolio by $4 million.

Investor Verification Checklist

• Separation Costs: Verify the one-time nature of the $15 million separation expense and its impact on future operating margins.
• Tax Asset Realization: Confirm the final status of the IRS ruling regarding the $144 million deferred tax asset related to R&D costs.
• Deal Mix Trends: Monitor whether the shift toward lower-margin hardware deals in Q3 is a temporary fluctuation or a structural change in revenue composition.
• Legal Exposure: Track the DOJ investigation regarding federal contracts to assess potential liability beyond the current $1 million reserve.
• Post-Separation Cash Flow: Evaluate the company's ability to generate sufficient operating cash flow to meet obligations without the centralized cash management previously provided by NCR.